COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT An enabling regulatory framework for the development of sovereign bond-backed securities (SBBS) Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on sovereign bond-backed securities

EN EN
EUROPEAN
COMMISSION
Brussels, 29.6.2018
SWD(2018) 252 final/2
CORRIGENDUM
This document corrects SWD(2018) 252 final of 24.5.2018.
This version corrects a mistake in Figure 3 on page 9, specifically: the ECB original capital
key for France should have read 0.142 rather than 0.242. The other values in the table which
depend via algebraic manipulation on this entry are also suitably corrected.
The text should read as follows:
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT
An enabling regulatory framework for the development of sovereign bond-backed
securities (SBBS)
Accompanying the document
Proposal for a Regulation of the European Parliament and of the Council
on sovereign bond-backed securities
{COM(2018) 339 final} - {SEC(2018) 251 final} - {SWD(2018) 253 final}
Europaudvalget 2018
KOM (2018) 0339
Offentligt
1
Table of contents
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT............................................................... 4
2. PROBLEM DEFINITION .................................................................................................................... 9
2.1. What is the problem?.........................................................................................9
2.2. What are the problem drivers? ........................................................................12
2.3. How will the problem evolve? ........................................................................15
3. WHY SHOULD THE EU ACT? ........................................................................................................ 16
3.1. Legal basis.......................................................................................................16
3.2. Subsidiarity (Necessity of EU action) .............................................................17
3.3. Subsidiarity (Value added of EU action).........................................................17
4. OBJECTIVES: WHAT IS TO BE ACHIEVED? ............................................................................... 17
4.1. General objectives ...........................................................................................17
4.2. Specific objectives...........................................................................................18
5. WHAT ARE THE AVAILABLE POLICY OPTIONS? .................................................................... 19
5.1. What is the baseline from which options are assessed? ..................................19
5.2. Description of the policy options ....................................................................22
5.3. Options discarded at an early stage .................................................................23
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? ........................................................... 24
6.1. Scenarios and benchmarks of benefits and costs.............................................24
6.1.1. Scenarios ............................................................................................................... 24
6.1.2. Benchmarks of benefits and costs ......................................................................... 24
6.2. Scope of applicability of the proposed legislation ..........................................25
6.2.1. Option 1.1: only SBBS proper .............................................................................. 25
6.2.2. Option 1.2: All securitisations of euro area sovereign bonds................................ 27
6.2.3. Option 1.3: A basket of euro-are sovereign bonds (with weights according to the
official "SBBS recipe") ......................................................................................................... 28
6.2.4. Impact summary and conclusions ......................................................................... 30
6.3. Extent of ’restored’ regulatory neutrality........................................................31
6.3.1. Option 2.1: Extend the regulatory treatment of euro area sovereign bonds to all
tranches 32
6.3.2. Option 2.2: Extend the regulatory treatment of euro area sovereign bonds only to
senior tranches....................................................................................................................... 33
6.3.3. Impact summary and conclusions ......................................................................... 34
6.4. Ensuring compliance with SBBS criteria and consistency in
implementation................................................................................................34
6.4.1. Option 3.1: A compliance mechanism based on self-attestation........................... 35
6.4.2. Option 3.2: Option 3.1, with the involvement of third-parties.............................. 37
2
6.4.3. Option 3.3: Option 3.1 with ex-ante supervisory checks on each issuance........... 38
6.4.4. Impact summary and conclusion........................................................................... 39
7. HOW DO THE OPTIONS COMPARE?............................................................................................ 40
8. PREFERRED OPTION ...................................................................................................................... 43
8.1. Preferred model ...............................................................................................43
8.2. REFIT (simplification and improved efficiency)............................................43
9. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?.................................. 43
LIST OF REFERENCES.............................................................................................................................. 45
ANNEX 1 PROCEDURAL INFORMATION ......................................................................................... 47
1. LEAD DG, DECIDE PLANNING/CWP REFERENCES.................................................................. 47
2. ORGANISATION AND TIMING...................................................................................................... 47
3. CONSULTATION OF THE RSB....................................................................................................... 47
4. EVIDENCE, SOURCES AND QUALITY......................................................................................... 47
ANNEX 2 STAKEHOLDER CONSULTATION .................................................................................... 48
1. RESULTS FROM THE ESRB PUBLIC SURVEY ON SOVEREIGN BOND-BACKED
SECURITIES...................................................................................................................................... 48
1.1 Senior SBBS....................................................................................................48
1.2 Junior SBBS ....................................................................................................52
1.3 Regulation........................................................................................................56
1.4 Economics of SBBS issuance..........................................................................58
2. SUMMARY OF THE INDUSTRY WORKSHOP............................................................................. 62
Session 1: Motivation................................................................................................63
Session 2: Sovereign debt markets............................................................................64
Session 3: Commercial banks....................................................................................65
Session 4: Non-bank Investors..................................................................................66
Session 5: Demand for junior SBBS .........................................................................67
Session 6: Risk measurement....................................................................................67
3. MAIN TAKEAWAYS OF THE CLOSED-DOOR DMO WORKSHOP........................................... 68
ANNEX 3 WHO IS AFFECTED AND HOW?........................................................................................ 69
1. PRACTICAL IMPLICATIONS OF THE INITIATIVE .................................................................... 69
2. SUMMARY OF COSTS AND BENEFITS ....................................................................................... 73
ANNEX 4 ANALYTICAL METHODS................................................................................................... 79
1. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT PRESENT ............... 79
2. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT POST
1/1/2019 .............................................................................................................................................. 81
3. PRESENTATION OF THE ANALYSIS BY THE ESRB LIQUIDITY WORKING GROUP
ON THE EFFECTS OF SBBS ON NATIONAL SOVEREIGN BOND MARKET
LIQUIDITY ........................................................................................................................................ 82
4. IMPACT ON THE VOLUME OF AAA ASSETS............................................................................. 97
5. IMPACT ON THE COMPOSITION OF BANKS' SOVEREIGN PORTFOLIOS ............................ 98
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Glossary
Term or acronym Meaning or definition
AIFMD Alternative Investment Fund Managers
BRRD Bank Recovery and Resolution Directive (Directive 2014/59/EU)
CCP Central Counter Parties
CET1 Core Tier-1 Capital
CIU Collective Investment Unit/Undertaking
CRD Capital Requirement Directive IV (Directive 2013/36/EU)
CRR Capital Requirement Regulation (Regulation (EU) 575/2013)
CSD Central Securities Depositories
DMO Debt Management Office
EBA European Banking Authority
ECB European Central Bank
EIOPA European Insurance and Occupational Pensions Authority
EMU Economic and Monetary Union
ESM European Stability Mechanism
ESRB European Systemic Risk Board
EU European Union
HLTF High Level Task Force
HQLA High-Quality Liquid Assets
IORP Institutions for Occupational Retirement Provision
IRB bank A bank using "Internal Ratings-Based" models to calculate its capital requirements
LCH London Clearing House
LCR Liquidity Coverage Ratio
NSFR Net Stable Funding Ratio
RTSE Regulatory Treatment of Sovereign Exposures
SA bank A bank using the "Standardised Approach" to calculate its capital requirements
SBBS Sovereign Bond-Backed Securities
SCR Solvency Capital Requirement
SPV Special purpose vehicle
SSM Single Supervisory Mechanism
STS securitisation Simple, transparent and standardised securitisation
TFEU Treaty on the Functioning of the European Union
UCITS Undertakings for Collective Investment in Transferable Securities
4
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT
A novel concept—that of Sovereign Bond-Backed Securities, or SBBS (see Box 11
)—
has attracted the attention of academics and policy makers alike as a possible tool to
address the "home bias" in banks' sovereign portfolios (see Box 2) and further weaken
the banks-sovereign nexus (see Box 3), two vulnerabilities that were at the heart of the
last financial and economic crisis.
SBBS are appealing because, by design, they would not suffer from some of the pitfalls
associated with other widely discussed reforms to address these key vulnerabilities, e.g.
the introduction of Eurobonds2
and a reform of the regulatory treatment of sovereign
exposure (RTSE) to discourage concentrated investment in sovereign bonds, especially
of the riskier ones. Specifically:
1. Differently from Eurobonds, SBBS would not involve mutualisation of risks and
losses among Member States. Risk/loss mutualisation is seen as problematic by
many because it might encourage moral hazard.
2. SBBS do not present the same risks for financial stability as would stem from an
untimely RTSE reform. It is precisely to ward off such financial stability risks that
the Commission's stance on RTSE, as reiterated e.g. in the May 2017 Reflection
Paper3
on deepening the economic and monetary union (EMU), is that it can only
happen once Banking Union, Capital Markets Union, and a European safe asset are
in place (section 2.3).
SBBSs are tranches issued against a diversified portfolio of euro-area central government
bonds. The diversification of the underlying portfolio and the conservative tranching
threshold (i.e., a sufficiently large loss-absorbing sub-senior tranche) would ensure a very
high level of safety for the senior tranche. The tranching would in effect concentrate
sovereign risk into the junior and, to a lesser extent, mezzanine tranches. If the latter two
tranches are bought by investors whose losses are less likely (than, say, those of banks)
to create spillovers to the public purse, the risk of feedback loops in case of stress in one
or more euro area sovereigns would be further reduced.4 5
An inter-institutional High Level Task Force (HLTF) was established in mid-2016 under
the aegis of the ESRB and the Chairmanship of Central Bank of Ireland Governor
Philip Lane to assess the feasibility, merits and risks of SBBSs. The European
Commission (henceforth, the Commission) has actively contributed to the work of this
task force, which also comprised representatives from 16 national central banks, the
ECB, the EBA, the EIOPA, as well as of Member States' Debt Management Offices and
academics (for the list of HLTF members, see Annex 1 of the HLTF report).
1
See also Brunnermeier et al. (2016b).
2
A classical Eurobond is a bond guaranteed jointly and severally by all participating Member States.
3
https://ec.europa.eu/commission/publications/reflection-paper-deepening-economic-and-monetary-union_en
4
An alternative way to pool sovereign bonds would be in a basket with a specific composition, which would be
equivalent to a securitisation with a single junior tranche (see section 6.2.3).
5
Of course, SBBS would per se not achieve the optimal overall diversification of banks' balance sheets. They
can help diversify banks' sovereign exposures. To the extent that banks also diversify geographically their
other assets (i.e., through cross-border lending to non-financial corporates and households) the sovereign-
bank nexus would be further weakened.
5
Based on the work conducted by the HLTF and its own analysis, in the above mentioned
May 2017 Reflection paper on deepening EMU, the Commission has put forward SBBS
as a possible tool that could be launched in the short term6
to enhance diversification of
banks' sovereign exposures.
In the Letter of Intent accompanying his 2017 State of the Union Address,
President Juncker has committed the Commission to propose by 2018 an "enabling
framework for the development of SBBS to support further portfolio diversification in
the banking sector."
Finally, in its October 2017 Banking Union Communication, the Commission reiterated
its view that SBBS "have the potential to contribute to the completion of the Banking
Union and the enhancement of the Capital Markets Union" by "support(ing) further
portfolio diversification in the banking sector, while creating a new source of
high-quality collateral particularly suited for use in cross-border financial transactions".
On this basis, the Communication notes that "building on the outcome of the [ESRB
HLTF] work in December 2017 and consultations with relevant stakeholders, the
Commission will consider putting forward a legislative proposal for an enabling
framework for the development of sovereign bond-backed securities in early 2018."
The HLTF has concluded7
that, while they would not address fully all the known
structural vulnerabilities of the euro area financial sector, SBBSs do have potential to
improve on the status quo. However, SBBS are unlikely to emerge under the current
regulatory framework, since the latter would impose on them additional charges and
discounts (relative to those faced by the sovereign bonds in the underlying portfolio),
making SBBS uneconomical to produce and unattractive to hold (see section 2.1).
The HLTF found that a gradual development of a demand-led market for SBBS may be
feasible under certain conditions.8
A key necessary condition, however, is for
an SBBS-specific enabling legislation to provide the conditions for a sufficiently large
investor base, including both banks and non-banks.
This impact assessment studies, therefore, whether and how to adapt the current
regulatory framework to better take into account the features and properties of these
novel instruments. Doing so would make it possible for SBBS to undergo a true "market
test", which is the only way to ascertain whether they are economically feasible or not
once relieved of the existing regulatory hindrances.
6
Other measures, such as a European safe asset, would require more analysis and more time (again, see EMU
reflection paper).
7
The final report is available at https://www.esrb.europa.eu/pub/task_force_safe_assets/html/index.en.html.
8
Many market participants have argued strongly that the viability of SBBSs would be greatly enhanced if the
junior tranches were supported by some form of public guarantee (for example replies to the public survey,
Annex 2, section 1 and DMO's views, annex Annex 2, section 3). As discussed below (see section 5.3), there
is no appetite to offer such guarantees. Indeed the key feature of SBBS, which has gained them support
among a cross-section of policymakers, is precisely that they would not involve any public support, and that
they would rather rely exclusively on mutualisation of risks among private investors.
6
9
Of course, no asset can be made to be fully safe. The analysis by the HLTF shows that a 70-percent thick senior
tranche would have a five-year expected loss rate of 0.5% or less ("at least as safe as German Bunds").
Box 1: The concept of SBBS
SBBS consist of different claims (tranches) of ranked seniority on an underlying diversified portfolio
of (euro area) sovereign bonds put together by a Special Purpose Vehicle (SPV) (see Figure 1).
Depending on how the market would develop, one or several arrangers would issue the
instrument. The weights of the various sovereign bonds in the underlying portfolio would be fixed (e.g., in
line with each country's GDP, or the ECB key), as would their tranching structure (i.e., number of
tranches—e.g., a senior, a mezzanine and a junior tranche—and tranching points). The portfolio would
initially cover central government bonds of euro
area countries. The scheme could start off at a
relatively small scale, and would be envisaged to
cover up to a fraction of Member States' bonds,
so as to leave a balance of national bonds in the
market, for market discipline purposes. As
mentioned, SBBS would be different from
classical Eurobonds in that they would not rely
on any risk sharing or fiscal mutualisation
between Member States.
Figure 1: Balance sheet of a special-purpose
vehicle issuing SBBS with three tranches
By virtue of this tranching with seniority, the
junior tranche would be first in line to take
any losses that might arise in the tail event of
a sovereign default. With an appropriate
tranching point, the intention is that the
senior tranche would constitute "safe" or low-risk assets.9
SBBS, and in particular the senior tranche, could potentially yield tangible benefits for the overall
financial architecture in Europe. In particular, they would help:
 Allow banks and other investors to diversify their sovereign bond portfolios—whose home
bias is presently a key conduit of the sovereign-bank nexus—at relatively low transaction
costs. This would thus help avoid the financial fragmentation observed over the course of the
sovereign debt crisis, when yield differences between euro area Member States widened.
With SBBS, safe haven flows would move also across instruments (i.e. from the junior to the
senior tranche) rather than just across borders (i.e., from sovereigns with weaker fiscal
positions to those with stronger ones.
 Alleviate safe asset scarcity in Europe: Expand the supply of (euro-denominated) "safe"
(high-rated) assets, which has been falling due to the many downgrades experienced in the
wake of the crisis, against the regulation-induced increased demand for high-quality liquid
assets, especially in the context of the Liquidity Coverage Ratio (LCR). Importantly, all
qualifying euro area Member States would indirectly contribute to such a high-rated asset.
So the gains from the "exorbitant privilege" of producing safe assets would be more evenly
shared than is the case now.
 Create a risk-free rate benchmark curve against which other securities could be priced.
 Create an asset that the ECB could use, if they so choose, to conduct monetary policy
operations without risking been perceived as supporting a particular Member State.
Basing the SBBS' underlying portfolio on the ECB key has several objectives:
 First, it is meant to ensure that the benefits (and any costs) associated with the expanded
supply of low risk assets accrue in a balanced manner to all euro area Member States. This is
an important consideration, not just in point of fairness, but also in terms of efficiency.
Specifically, if SBBS manage to become a ’benchmark’-like security, they (in particular
their senior tranche) may be used by investors as a low-risk alternative to build or to unwind
Assets Liabilities
Junior tranche
Euro area (central)
government bonds
(e.g., ECB capital key
weights)
Senior Tranche
Mezzanine trance
7
Box 2: The bank-sovereign nexus
Sovereign and banking stress can reinforce each other through a number of channels,
especially in times of economic stress. A worsening of the financial situation of the sovereign
leads to deterioration in the market value of government debt, including that held by the banks,
reducing their loss absorption capacity (at market prices) and hindering their ability to lend to the
economy.10
In turn, this further depresses economic activity, lowering tax revenue and adding to
the funding pressure on the sovereign. In the past, the state was furthermore perceived to provide
the ultimate backstop to ensure banking stability, either by injecting capital or by providing
liquidity. Therefore, banking stress increased the contingent liabilities for the government, raising
its financing costs. This further exacerbated the feedback loop.11
Figure 2: The bank-sovereign nexus
Source: Brunnermeier et al. (2016b)
The sovereign-bank nexus was one of the main factors amplifying financial distress in the
euro area during the last financial and economic crisis. High stock of public debt in Greece
and Italy combined with increased exposure of these countries' banking sectors (and, in the case
of Greece, of Cypriot banks also) to sovereign finances. Meanwhile, imprudent lending practices
by Irish, Spanish and Slovenian banks built up high and in some cases excessive risk on bank
10
This channel is exacerbated in countries with high levels of government debt or where there is prevalent home
bias in banks' sovereign portfolios (Box 3).
11
For a more detailed discussion, also Banca d'Italia (2014).
positions in euros. This means, for example, that if there is an increase in the demand for
’low risk’ euro exposures, investors could purchase the (senior) SBBS rather than the bonds
of the (select) high rated euro-area Member States. As a result, any downward pressure on
interest rates would be spread throughout the euro area, and not skewed to benefit only a few
Member States and the borrowers in these jurisdictions. This is positive for Member States
that would otherwise not benefit from this enhanced demand for euro exposure, and also for
high-rated Member States, which otherwise could experience unduly low interest rates,
potentially leading in turn to overheating, misallocation of investment, as well as to
challenges for some investor classes (e.g., pension funds).
 Second, it is meant to facilitate standardisation of SBBS over time, as the ECB key is
relatively stable (especially if applied on multi-year averages of the underlying determinants,
e.g. population and GDP levels).
 Finally, it is meant to avoid potential moral hazard associated with other likely candidates for
standardised portfolio composition, and in particular with the relative share of outstanding
individual governments' debt on the total (as countries with larger debt stocks would then
benefit disproportionately).
8
balance sheets, and subsequent public intervention put significant strain on the finances of their
respective sovereigns.12
The concomitant hikes in funding costs put significant strain on
economic activity in these countries.
Thus, addressing this feedback loop enhances financial stability and increases resilience.
Mitigating the link between sovereign and financial stress through prudent policy making, greater
asset diversification and building up credible backstops, would reduce the overall level of risk in
the economy. In turn, this would limit the cost of sunspot-driven crises, thereby enhancing
financial stability.
Several important steps have been taken in recent years towards a full Banking Union, thus
weakening the bank-sovereign nexus. For example, (major) euro-area banks are now
supervised at the EU level (by the SSM) and (if necessary) resolved by the Single Resolution
Mechanism supported by the Single Resolution Fund. Furthermore, a backstop for the Single
Resolution Fund is being established, which means that banks can be resolved efficiently and
effectively, irrespective where they are headquartered. Furthermore, the Commission has
proposed the establishment of a backstop to the Single Resolution Fund, to be provided by the
ESM, or the (future) European Monetary Fund.13
Box 3: The home bias in banks' sovereign portfolios
A key factor that strengthens the link from a sovereign to its banks is the so-called "home
bias" in banks' sovereign bond portfolios, i.e. banks are typically most exposed to their own
sovereign. This home bias actually increased in the wake of the euro area debt crisis, in particular
in more vulnerable Member States, even if more recently, also supported by government bond
purchases by the ECB, banks have somewhat reduced their holdings of government bonds.
The table in Figure 3 reports the size of banks' holdings of bonds of their own sovereign in EU
Member States, both in nominal value as a share of banks' overall sovereign bond portfolios.
When this share is disproportionately large (for example, compared to the Member State's share
in the ECB capital key), it gives rise to so-called "home bias".
As shown in Figure 3, the degree of "home bias" is not homogenous within the euro area, with
the share of exposure to the home sovereign relative to the total of sovereign exposures ranging
from 8.3% (Luxembourg) to 61.3% (Slovenia) in the sample. This share is generally well above
each Member States' share in the ECB capital key, except for French banks.14
Several factors can explain why a bank would prefer holding bonds issued by its home
sovereign. The first one is simply the better knowledge of the home sovereign's creditworthiness
(see Persaud (2017)), compared to that of more remote sovereigns. Another one refers to possible
differences in perceived default probabilities: investors (and banks in particular) might believe
that a sovereign in financial difficulty may try to prioritise servicing its domestic debt (and in
particular, domestic banks) over bonds held by foreign investors (see Guembel and Sussman
(2009)). In addition, banks may also accumulate domestic sovereign exposure if they consider
that the additional risk of holding such debt is negligible: if the home sovereign was to fail, the
bank is likely to fail anyway, since its exposures to the domestic economy are likely to sour.15
Finally, domestic banks may be subject to "moral suasion". In particular, government-owned
12
See Erce. A (2015) for a discussion of the factors which affect the extent of spillovers from banks to the
sovereigns, such as the size of the banks' balance sheets, the structure of their liabilities, and the level of non-
performing loans.
13
https://ec.europa.eu/commission/publications/completing-europes-economic-and-monetary-union-
factsheets_en
14
Recent data show a reduction in euro area banks' holdings of government debt by 17% between 2015 and
2017, which thus also reduces their financial connection with their sovereign.
15
As Horváth, B L, H Huizinga, and V Ioannidou (2015) put it: "additional domestic sovereign exposure cannot
hurt them (banks) much, because they are likely to fail anyway if their sovereign defaults".
9
banks and banks under political influence (through government seats at the Board of directors)
report higher home bias in sovereign debt, and such moral suasion is stronger in countries under
stress (see De Marco and Macchiavelli (2016)).
Figure 3: Banks' exposure to domestic sovereign bonds as of 30 June 2016
Source: EBA 2016 Transparency Exercise; ECB (for capital key)
Notes: 1/ Rebased to 100 using only listed Member States; 2/ difference between figures in third and fifth columns.
Some commentators have associated banks' home bias in sovereign exposure with the regulatory
treatment of sovereign exposures, since sovereign debt denominated in the domestic currency is
considered risk-free, providing banks with strong incentives for holding such bonds. However,
this doesn't explain the prevalence of the home bias in the euro area, since all sovereign bonds
from euro area countries are treated in the same way for euro area banks.
2. PROBLEM DEFINITION
2.1. What is the problem?
The problem that the proposed initiative would address is that the current regulatory
framework impedes the development by the private sector of SBBS.
This is because, under the current regulatory framework, SBBSs would be treated as
securitisation products, and hence significantly less favourably—along several
dimensions—than their underlying portfolio of euro area sovereign bonds (see Box 4).
For example, banks would face lower capital requirements (indeed, zero) by holding the
underlying sovereign bonds rather than SBBS tranches. Moreover, whereas banks
currently extensively use euro area sovereign bonds for the purposes of meeting liquidity
coverage requirements (LCR and NSFR), as well as collateral (including to access
liquidity from the ECB), SBBS tranches would not be eligible for these key purposes.
Thus, unless the regulatory framework is suitably adapted, investors would always rather
prefer to invest directly in the underlying government bonds than in SBBS.
Original Rebased 1/
Austria 58,968 11,666 19.8% 2.0% 2.8% 16.9%
Belgium 118,370 26,683 22.5% 2.5% 3.6% 19.0%
Cyprus 2,428 907 37.4% 0.2% 0.2% 37.2%
Finland 7,936 1,103 13.9% 1.3% 1.8% 12.1%
France 466,817 136,980 29.3% 14.2% 20.5% 8.8%
Germany 331,943 118,091 35.6% 18.0% 26.1% 9.5%
Greece 55,552 12,333 22.2% 2.0% 2.9% 19.3%
Ireland 30,487 15,301 50.2% 1.2% 1.7% 48.5%
Italy 364,109 152,690 41.9% 12.3% 17.8% 24.1%
Latvia 1,565 262 16.7% 0.3% 0.4% 16.3%
Luxembourg 7,961 657 8.3% 0.2% 0.3% 8.0%
Malta 1,845 869 47.1% 0.1% 0.1% 47.0%
Nederlands 161,124 41,199 25.6% 4.0% 5.8% 19.8%
Portugal 43,333 23,039 53.2% 1.7% 2.5% 50.6%
Slovenia 3,335 2,045 61.3% 0.3% 0.5% 60.8%
Spain 374,275 86,451 23.1% 8.8% 12.8% 10.3%
Total 2,030,047 630,274 31% 69.0% 100.0% n.a.
ECB key "home bias"
proxy 2/
Sovereign bonds
(million EUR)
Home sovereign
bonds (million
EUR)
Home sovereign
bonds / total
sovereign bonds
10
This has been confirmed by the many interactions with market participants (both
candidate producers and candidate buyers of SBBS) in consultations conducted in the
context of the HLTF work on SBBS. It is for this reason that the HLTF report concludes
that, "ultimately, the level of investor demand for SBBS and its impact on financial
markets is an empirical question, which can only be tested if an enabling regulation for
the securities is adopted".
Box 4: SBBS versus government bonds in the existing regulatory framework
Under the current regulatory framework, SBBS would be treated as securitised products because
they entail tranching and subordination of credit risk. In regulation, these two elements define a securitised
product, regardless of the underlying composition of the portfolio or its risk.16
As a direct consequence of this fact, SBBS would receive an unfavourable treatment compared with
that of the underlying sovereign bonds along several dimensions, as described below.
Capital requirements
For financial institutions (banks), holding a securitised product rather than the underlying portfolio
gives rise to higher capital requirements. The justification for such non-neutrality in the treatment of
securitisations relative to that of the underlying portfolio comes from model risk (i.e. a higher sensitivity of
the securitisation price to errors in estimating probabilities of default, losses given default, and default
correlation of the underlying assets). Non-neutrality is also justified by agency risk, since securitisation
involves a greater number of parties with potentially conflicting interests (e.g. servicing, counterparty, and
legal risk) than does holding the underlying assets.17
In particular, as per the Capital Requirements Regulation (CRR, Regulation (EU) No
575/2013, Articles 242-270), generally18
there is a floor for the risk weight on securitisation
positions of 7% for banks using the Internal Ratings Based approach (IRB banks) and 20% for
banks using the Standardised Approach (SA banks).
As regards instruments held in the trading book, SBBS would face significant higher
charges for interest rate risk. Sovereign bonds in the trading book are subject to a small capital
charge for interest rate risk. By contrast, securitised products need to be supported by capital of
8% of the amount calculated under the banking book.19
Risk weights to account for general risks
would be, instead, similar for SBBS and sovereign bonds, if the two instruments have the same
duration and market value. In particular, the treatment of specific risk in the Standardised
Approach is similar to the one for credit risk, in practice leading to a zero risk weight for specific
risk.20
SBBS would not qualify as a simple, transparent and standardised securitisation (STS)
under the recently approved STS legislation (Regulation (EU) 2017/2402). The latter explicitly
excludes securitisations of “transferable securities” (such as sovereign bonds) from the products
16
Article 4(61) of the CRR.
17
A third factor in typical securitisation is that the underlying securitised loans are not exposed to market risk
(since they are not tradeable), in contrast with the securitised product.
18
In some cases (see for instance Articles 252 and 260 of the CRR) caps may be allowed that could result in
lower risk weights for SBBS tranches than the floors mentioned here. Similarly, Regulation (EU) 2017/2401,
which comes into force on 1/1/2019, will allow IRB banks that are capable of assessing the risk
characteristics of each individual asset in the underlying pool to apply a maximal capital requirement for
securitisation positions equal to the capital requirements if the underlying exposures had not been securitised.
Depending on the risk weights of the underlying exposures, this could imply a lower risk weight than the
floor, including for non-senior bonds. It needs to be kept in mind that many IRB banks have a risk weight
higher than 0% on their sovereign exposures. Thus, even if the cap is applied, the risk weights for senior
SBBS would not necessarily be 0%.
19
Article 337 of the CRR.
20
Article 336 of the CRR, Table 1 translates a 0% risk weight in the banking book to a 0% risk weight in the
trading book.
11
that may qualify as STSs, since it aims at spurring banks to originate new loans (especially to
SMEs) in support of the real economy, as opposed to repackaging the debt of financial entities or
government bonds. Moreover, for a securitisation to qualify as STS, no single underlying asset
can exceed 1% of the total portfolio. In the case of SBBS constructed in line with the ECB capital
key, this limit would be exceeded by the sovereign bonds of 11 Member States.
For insurance companies, Solvency II provides two ways of calculating the Solvency Capital
Requirement (SCR): an internal model (either full or partial) or the standard formula. The
standard formula defines explicitly which risks are to be taken into account in the SCR
calculation. By contrast, internal models, which are subject to supervisory approval, give
insurance companies a high degree of flexibility. But there is a requirement to take into account
all material quantifiable risks that are in the scope of the model in the determination of the
regulatory capital requirement.
Under the Solvency II standard formula, any securitisation is subject to capital
requirements related to spread risk in the calculation of the SCR. SBBS would therefore be
subject to capital requirements for spread risk and put at a disadvantage relative to direct holdings
of Member State central government bonds denominated and funded in domestic currency (which
would not be subject to such requirements).
A general look-through approach in the standard formula exists under Solvency II for
exposures to investment funds, but not for securitised products. Nevertheless, there is a
“partial look-through” requirement resulting from the fact that securitisations have to be included
in the calculation of the capital requirements for interest rate risk.
Capital rules for pension funds are not fully harmonised at EU level. In particular, applying
capital requirements to securitised products is at the discretion of national legislators.
Liquidity and collateral
While all euro area government bonds qualify as level-1 asset under the EU’s liquidity
coverage ratio (LCR), SBBS would not, by virtue of being considered as securitisation
positions. At present, senior tranches of asset-backed securities can be at best level-2b assets and
subject to a 25% minimum haircut under specific criteria set out in Commission Delegated
Regulation (EU) 2015/61. SBBS would not qualify for this treatment, since sovereign bonds are
not included in the list of eligible underlying exposures.21
The same disparity of treatment
between SBBS and their underlying sovereign bonds occurs as far as the net stable funding ratio
(NSFR) is concerned, as the latter adopts the same definition of liquid assets as the LCR.
SBBS would compare unfavourably to their underlying government bond also in terms of
usability as collateral—a key determinant of financial assets’ liquidity. The Financial
Collateral Directive (Directive 2002/47/EC) makes no distinction between bonds and securitised
products, meaning that it protects them legally in the same way. In practice, market data on the
use of collateral in repurchase transactions suggest that only a small share of them use securitised
assets as collateral (for example, securitised products are not part of any global collateral baskets
of major clearing houses such as Eurex and LCH). In contrast, government bonds are used
heavily as collateral and in securities lending. Utilisation rates are about 50% for German, 30%
for French and 15% for Italian sovereign bonds.22
The extent to which SBBS could be usable as
collateral is likely to be limited under the current regulatory framework, in part because they are
not eligible as collateral in central bank operations23
(the latter is considered a necessary, but not
21
Article 13(2)g of Commission Delegated Regulation EU No 2015/61.
22
Using data from Markit Securities finance, the monetary advantage of being eligible for use as collateral
would be around 15 basis points when euro area average fees for securities lending are taken as a proxy, and
close to 20 basis points for German and French sovereign bonds.
23
Government bonds are presently not foreseen in the list of eligible assets for eligible securitisations in the
ECB’s collateral framework. Moreover, all securitisations presently command by default a 15% minimum
haircut.
12
sufficient, condition for usability as collateral in private repurchase transactions—for example
central securities depositories (CSD) may accept instruments, beyond sovereign bonds or other
publicly guaranteed bonds, if these are eligible at a central bank from which the CSD banking
service provider has access to regular, non-occasional credit).
Investment rules and restrictions
For several types of investors, positions in SBBS may be subject to stricter limits than
positions in sovereign bonds. As a general rule, banks, insurance companies, but also
Alternative Investment Fund Managers (AIFMD) and undertakings for collective investment in
transferable securities (UCITS) can invest in securitised products only if originators retain a
material net economic interest. SBBS would however not be subject to this limitation, because
they can be considered exposures to Member State central governments denominated and funded
in the domestic currency of those central governments.24
However, the following restrictions do
apply:
 UCITS need to respect diversification rules, which may prevent them from holding
large volumes of SBBS. While Member States may authorise UCITS to invest up to 100% in
transferrable securities issued or guaranteed by a public body, this exception may not be
available for SBBS.25
 The Money Market Funds Regulation currently under negotiation26
may restrict money
market funds from investing in SBBS. Although the focus of money market funds on
investments with short maturities suggests they are unlikely to be the main investors in SBBS
across the entire term structure, they could still play a crucial role for the liquidity of SBBS
by accepting them as collateral in private repurchase transactions if this would be allowed.
 Central Counter Parties (CCP) may in principle be able to invest in SBBS under
current rules, if they are considered to be highly liquid. In line with their investment
policies, however, they would probably not be able to invest in junior SBBS since these
securities would be perceived as too risky.
 For insurance companies, the Solvency II framework sets out specific due diligence and
risk management requirements for securitisation positions.27
 For IORPs, Article 19 of Directive (EU) 2016/2341, to be transposed into national law
by 2019, sets out provisions in relation to the prudent person rule, including limits to
excessive risk concentration. Member States may choose not to apply the diversification
requirements to investments in government bonds. Moreover, Member States may impose
quantitative restrictions for securitisations. Article 25 of Directive (EU) 2016/2341
specifically mentions the need for an IORP’s risk management system to address in a
proportionate manner risks which can occur in the area of investments, in particular
derivatives, securitisations and similar commitments, where applicable.
2.2. What are the problem drivers?
The key driver of the problem is that the current regulatory framework of securitisations
does not adequately take into account all the properties of SBBS. This is not surprising,
considering that SBBS are a novel concept that does not yet exist.
24
See, for example, Art. 255 of Commission Delegated Regulation EU No 2015/35.
25
Directive 2009/65/EC (UCITS) imposes diversification on UCITS. Although Art. 54 derogates from Art. 52
and the principle of risk-spreading to allow investments up to 100% in transferable securities issued by the
same entity (i.e. same issuer or same guarantor), SBBS are currently not listed as possible beneficiaries of
this exemption. Moreover, there is a requirement of diversification across different maturities.
26
Commission proposal COM/2013/615.
27
Art. 4(5) and (6) of Commission Delegated Regulation EU No 2015/35 requires insurance companies to
produce their own internal credit assessment for type-2 securitisations. Art. 256 sets out due diligence and
risk management requirements including stress testing for securitisations.
13
In the current regulatory framework, securitisation products attract higher regulatory
charges/discounts than direct investments in the corresponding underlying assets. The
framework, in other words, is not neutral between investing directly in some assets
vis-à-vis investing in structured products backed by these same assets.
The general justification for such non-neutrality comes from securitisation-specific risks,
having to do primarily with sharply asymmetric information between the originator of the
securitisation products and the investors. This asymmetry of information is typically
compounded by the opaque nature of the securitised assets and the complexity of the
structure.
These risks include:
 Agency risk. Originators know substantially more than investors about the assets
composing the securitisation pool. This is obviously the case, e.g., with a bank that
issues mortgages and then securitises them. An investor does not have access to the
same information on the mortgage borrowers as the bank. He/she also can assume
that the bank may have an incentive to securitise first/only the least profitable/more
risky mortgages. It is because of this agency problem that many institutional
investors as well as banks are prevented from investing in securitisations unless the
issuer retains a significant "skin in the game".
 Model risk. As a result of tranching, pay-outs are non-linear (some investors are paid
even if others are not). This generates a higher sensitivity of the price of the
securitised products to errors in estimating probabilities of default, losses given
default, and default correlations of the underlying assets.
 Legal risks. These stem from the fact that there is an additional counterpart involved
(i.e., the arranger of the securitisation) and the complexity of the product (e.g.,
generating uncertainty as to the correct application of the payment waterfall under all
future scenarios).
Yet, SBBS are a sui generis securitisation along several key dimensions:
1. Many of the asymmetries of information and, to an extent, the complexities of the
structure are not present when, as is the case for SBBS, the underlying pool is
composed of euro area central government bonds. These assets are the workhorse of
European financial markets. They are well known and understood by market
participants. Moreover, the structure of the underlying asset pool for SBBS would
basically be predetermined (e.g., in the basic model, the weights of the individual
Member States' central government bonds would be in line with the ECB key).
Hence there is no asymmetry of information between the issuer and the investor.
Indeed, in theory, the issuer/assembler could be a robot.
2. Euro area sovereign bonds are also traded (which means, anyone can get a financial
exposure to them without having to resort to a securitisation) and (for the most part)
liquid (both de facto and, equally importantly, de jure—in the sense that they are
treated as such in regulation).
This means that the securitisation-specific regulatory charges are not justified in the case
of a securitisation of euro-area sovereign bonds (especially one which is assembled
14
followed a pre-defined methodology/recipe, as is the case for the particular SBBS studied
by the ESRB HLTF, and described in Box 1).
Under the current regulatory framework, SBBS face a similar problem as that which has
been addressed with the recent Simple, Transparent and Standardised (STS) regulation.
Specifically, the rationale for the recent STS regulation is that, in the presence of
securitisations which are structured in a particularly simple, transparent and standardised
way, failing to recognise such properties with a specific (and, in practice, more
favourable) regulatory treatment would have hindered their development.
Given the special nature of their underlying assets, namely euro-area central government
bonds, for SBBS the wedge between the regulatory treatment of (traditional)
securitisations and the actual risk/uncertainty of the instrument is even more pronounced
than was the case for STS securitisations. This is for two reasons: (1) the underlying
assets—namely, euro-area sovereign bonds—are even more simple, transparent and
standardised; and (2) euro-area sovereign bonds receive the most favourable regulatory
treatment in light of their properties and functions in the financial sector.
In addition, investment decisions as regards government bonds are particularly sensitive
to costs and fees (again, because of the volumes involved, the competition, their being in
effect "benchmarks", etc.). Relevant costs, from the viewpoint of a financial institution,
do include the cost of capital associated with the purchase of such assets. This means that
failure to address this regulatory issue is likely to have a correspondingly greater
impeding effect on the developments of the market for SBBS than would have, for
example, been the case for STS securitisations.
Box 5: Why is regulatory non-neutrality a problem only for SBBS?
Despite facing higher regulatory charges (in the form, e.g., of surcharges in the calculation of
capital requirements for banks/insurance companies, or limited/reduced usability of structured
products as collateral) than investing directly in the underlying asset pool, market participants
typically do engage in assembling, marketing and investing in (traditional) securitisations, such
as Mortgage-Backed Securities (MBS).
This is because traditional securitisations create value by not only redistributing the credit risk of
the underlying pool, but also by creating liquidity. Through traditional securitisation, a set of
assets which are typically individually non-tradeable, opaque, and risky, can be repackaged in
tranches with different economic features. In particular, the senior tranche, by virtue of the
combined support from diversification of the underlying portfolio (which can reduce, and in the
limit, eliminate diversifiable risks) and the existence of a sub-senior tranche acting as first-loss
absorber, can become a highly-rated, tradeable and liquid asset. Thus, through securitisation,
even an investor who is restricted – by either the law or its individual investment
mandate/charter – to invest only in liquid and highly-rated assets can gain exposure to projects
(e.g., mortgages) which individually would not have had these required properties. Hence this
investor may be willing to incur the regulatory charges associated with a securitisation tranche if
he/she values high ratings and liquidity sufficiently. Moreover, and importantly, for some
underlying assets (in particular, non-traded mortgages or loans issued by a bank), an investor may
simply have no other way of securing an exposure than indirectly by buying a stake in the
structured product backed by such assets.
These supporting considerations do not apply to SBBS securitisations, given their sui generis
nature. In particular, since the underlying assets, i.e. euro area central government bonds, are
individually tradeable and liquid, there is no need to resort to a securitisation to gain exposure to
such instruments, nor can one, by doing so, gain in terms of, say, liquidity – indeed, if anything,
15
it is quite likely that until and unless an SBBS market of sufficient size develops, each individual
underlying bond would be more liquid than any of the SBBS tranches.
In sum, securitisation in the case of SBBS only serves as a tool to concentrate the risk of the
underlying sovereign portfolio in one instrument (the junior tranche), and relieve of it from
another (the senior tranche). But there is not much scope for improving on the ratings of the
safest of the underlying assets, nor to create liquidity. Thus, unless SBBS securitisations are
granted the same treatment as their underlying sovereign bonds, they will not be produced or
demanded by the private sector.
2.3. How will the problem evolve?
In the baseline (with no intervention) the regulatory hindrances deriving from the gap
between the regulatory treatment of SBBS and that of their underlying sovereign bonds
may diminish somewhat over time, in particular for banks, but are unlikely to disappear
altogether.
In particular, the recent revision of the CRR (Regulation (EU) 2017/2401), which is
expected to come into effect in 2019, could result in reduced regulatory surcharges faced
by SBBS vis-à-vis government bonds in terms of Pillar-1 capital requirements.
Specifically, under certain conditions (see footnote 18), senior tranches may be able to
benefit from a zero risk weight after application of the "look-through" principle, which
will be possible not just for banks sponsoring/originating securitisations – as is currently
the case – but also for banks investing in them. Non-neutrality for Pillar-1 capital
requirement purposes would be established also for sub-senior tranches for the subset of
banks using Internal-Ratings Based models (IRBA-banks), but not for others.28
Nevertheless, important sources of unfavourable regulatory treatment – most notably in
terms of liquidity-related regulation – would remain, including for the senior SBBS.
The HLTF report points out that, if RTSE were to be reformed and, for example, capital
charges for banks' sovereign exposures were to be introduced and made sensitive to
concentration or credit risk, senior SBBS may become more attractive, compared to their
underlying sovereign bonds, for banks by virtue of SBBS' greater diversification/safety.
This might offset some of the regulatory hindrances associated with "undue"
securitisation-related additional regulatory charges. At the same time, the report notes
that this finding does not pertain to the overall merits or demerits of RTSE reform.
Therefore, for the baseline, we assume no RTSE change would take place. This is also in
line with the conclusion of the discussions at international level (in the Basel Committee
on Banking Supervision).29
Any reform of RTSE would have profound implications in
terms of financial stability. Thus the European Commission has clearly stated that it
considers that a reform of the prudential treatment of sovereign exposures can only
happen after several pre-conditions are in place, including a full Banking Union and
substantial progress towards a Capital Markets Union and the existence of a European
28
See section 2, Annex 4 for some quantitative indication of the extent of the problem even after the entry into
force of the new securitisation framework per regulation (EU) 2017/2401, expected for 1/1/19.
29
The issues discussed are summarised by the Basel Committee in the December 2017 Discussion Paper on "The
regulatory treatment of sovereign exposures" available at https://www.bis.org/bcbs/publ/d425.htm. In
presenting it, the Committee notes that it "has not reached a consensus to make any changes to the treatment
of sovereign exposures, and has therefore decided not to consult on the ideas presented in this paper."
16
safe asset. In addition, if a level playing field for Europe’s financial sector is desired, an
agreement at the global level would also be essential.
A European safe asset, a new financial instrument for the common issuance of debt, is a
necessary step in the completion of the EMU architecture (European Commission, 2017).
It would need to be sizeable enough to become the benchmark for European financial
markets, and create a large, homogenous and liquid EA-level bond market, avoiding
sudden stops and financial fragmentation, and increasing the total European and global
supply of safe assets. The Commission will further reflect on different options for a safe
asset for the euro area in order to encourage a discussion on the possible design of such
an asset, separately from the present discussion on the introduction of an enabling
framework for SBBS.
As regards insurance companies and other asset managers, no changes are expected in
the baseline as regards the regulatory disincentives/limits to hold SBBS as opposed to the
underlying sovereign bonds.
In a nutshell, Figure 4 summarises the elements of the "problem tree" (i.e., problem,
driver, and consequences), as described in section 2.
Figure 4: The Problem Tree
3. WHY SHOULD THE EU ACT?
3.1. Legal basis
SBBS are a tool to enhance financial stability and risk sharing across the euro area. They
can thus contribute to the better functioning of the internal market. Article 114 TFEU,
that confers to the European institutions the competence to lay down appropriate
provisions that have as their objective the establishment and functioning of the internal
market, is thus the appropriate legal basis.
Drivers
•D1. The current
regulatory framework
does not adequately
capture all the
properties of SBBS
Problems
•P1. SBBS face "extra"
regulatory charges and
discounts when
compared to their
underlying sovereign
bonds
Consequences
•C1. There are
unwarranted
disincentives for the
private sector to
assemble, sell and/or
invest in SBBS
•C2 No sizeable market
for SBBS can emerge
17
3.2. Subsidiarity (Necessity of EU action)
Identified regulatory impediments to the development of SBBS markets are laid down in
several pieces of EU legislation (e.g. Regulation (EU) 575/2013 (CRR) on the prudential
treatment of credit risk or market risk for banks; Delegated Regulation (EU) 2015/35
(Solvency II) on spread risk on securitisation positions for insurance companies; or
Directive 2009/65/EC (UCITS), on eligibility criteria, concentration limits and
diversification requirements for UCITS). As a consequence, on a point of law, individual
Member State action would not be able to achieve the goals of this legislative initiative,
i.e. to remove such regulatory impediments, since amendments of EU legislation can
only be done through EU action.
But even aside from this legal consideration, action at the Member States' level would be
suboptimal. It could result in different instruments being "enabled" in different Member
States. This would render the market rather opaque and split market demand in various
different instruments, which would make it difficult (or even impossible) for any one of
them to acquire the requisite standing in terms of size and liquidity. Furthermore, even if
national legislators would address the same instruments by steps to remedy the currently
disadvantageous regulatory treatment, a race between national legislation could emerge
to offer as favourable as possible regulatory treatment. Furthermore, in both cases, i.e.
addressing differently defined products or giving different regulatory treatment, such
different national legislations would create de facto obstacles to the Single Market
(e.g., high compliance costs for an arranger that would want to operate in multiple
jurisdictions). For all these reasons, action at the EU level is necessary and appropriate.
These obstacles would have sizeable effects, given the very high integration of the
underlying government bond markets and the identical regulatory treatment of these
across the EU.
3.3. Subsidiarity (Value added of EU action)
Establishing an appropriate regulatory framework for this novel product, which—as
mentioned above, can only be done via action at the EU level—has value added insofar
as it may enable the development of an additional market through which financial risks
can be better shared, thus promoting financial stability as well as lower overall borrowing
costs for sovereigns and private sector agents.
4. OBJECTIVES: WHAT IS TO BE ACHIEVED?
4.1. General objectives
The general objective is to remove identified regulatory impediments against a (privately
produced, not mutualised) liquid, low-risk asset, such as the (senior) SBBS. Such an
asset could facilitate private sector risk sharing—especially across borders—and risk
reduction. This would strengthen the Banking Union.
In particular, as summarised in Box 1 and discussed at greater length in Brunnemeier et
al (2016b), ESRB HLTF (2018a) and ESRB HLTF (2018b), a pan-euro area low-risk
asset such as the senior SBBS could facilitate the diversification of euro area banks'
sovereign portfolios. This would reduce the extent of "home bias" in banks' balance
18
sheets, which despite recent progress remains rather high in some Member States. This,
in turn, would foster stability in the euro area: it would weaken the nexus between banks
and their sovereign and it would spread perceived idiosyncratic sovereign risk more
widely across borders within EMU.
A low-risk asset like the (senior) SBBS could also help avoid that exogenous capital
flows in search of "safety" affect the cross-section of euro area funding costs in an overly
unequal manner, as in practice is the case at present since only sovereign bonds of a few
Member States are at present perceived to be very low risk. It could also help address the
increasing relative scarcity of euro-denominated low-risk/high-rated assets resulting from
increasing demand for such assets—also due to regulatory requirements on financial
institutions (e.g. Liquidity Coverage ratio (LCR), Net Stable Funding Ratio (NFSR),
etc.)—against a background in which the assessed creditworthiness of several EU and
euro area Member States has deteriorated in the wake of the global financial crisis.
Importantly, such an asset is meant to be solely based on private-sector initiatives,
without the possible support of any (perception of) mutualisation of risks and/or losses
among EU Member States. This is a key desideratum, and will need to be kept in mind in
determining the specific content of any proposed initiatives.
4.2. Specific objectives
For an asset like the SBBS to be "enabled", the following two objectives would have to
be achieved:
1. Eliminate undue regulatory hindrances (i.e., restore regulatory "neutrality" for SBBS
securitisations).
2. Encourage liquidity and "benchmark" quality (i.e., the new instrument should be
treated like other benchmarks in regulation—de jure liquidity—and should be
capable of attaining a sufficient critical mass/standardisation so as to be liquid also
de facto).
Importantly, removing undue regulatory hindrances, by assuring that the product is
treated as its underlying government bonds, is only a necessary condition for the
development of such markets, but does not guarantee it—after all, SBBS are meant to be
developed by the private sector. The actual development of such a market, after the
removal of identified regulatory hindrances, will rather depend on the economic viability
of the product, i.e. on whether it will be advantageous for investors to acquire them and
private arrangers to issue them—this in turn depends on the extent to which the new
products would become "benchmarks" and easily traded, among other considerations
(e.g., the strength of the demand for sub-senior tranches, etc.). The HLTF report has
extensively analysed the issue and concluded that ultimately only a "market test" would
be able to settle remaining doubts as to the viability of SBBS. The specific objective of
the proposed regulatory framework is indeed to enable such a market test. In contrast, the
regulation will not, as discussed further in Section 5.3 below, provide incentives to the
development of SBBS markets, besides—that is—removing identified regulatory
obstacles.
19
5. WHAT ARE THE AVAILABLE POLICY OPTIONS?
Given the problem definition above, the first policy choice to be made is between keeping
the status quo (i.e. "do nothing", or baseline) versus introducing a legislative proposal to
enable the development of SBBS market ("an enabling framework for the development of
SBBS," in the language of President Juncker's September 2017 Letter of Intent).
If it is found opportune to introduce such a legislative proposal, two main policy choices
would need to be made, namely on the scope of applicability of the proposed legislation
and on the extent to which the legislation should enable the various tranches. Given this,
five main "models" for the proposed legislation are seen as deserving in-depth
consideration (see Figure 5). Separately, a third key policy choice has to be made as to
how to ensure compliance with the proposed new legislation itself. Here three options
are assessed, i.e. self-certification on its own, or complemented, respectively, with a third
party assessment or ex-ante supervisory approval.30
5.1. What is the baseline from which options are assessed?
The baseline is the status quo, i.e. no legislative intervention and unchanged RTSE (see
earlier discussion on page 15). In this scenario, SBBS are likely to remain an interesting
theoretical construct, but would not be produced and made available to investors. This is
because they would face significant additional regulatory charges (e.g., in terms of
required capital), discounts (e.g., in terms of eligibility for liquidity requirements), and
limits (in terms of investability for some market players) as compared with their
underlying sovereign bonds, which will render them unappealing or prohibitively
expensive.
To gauge the extent of regulatory hindrance faced by SBBS in the baseline, the HLTF
report shows that, if the banks covered by the EBA 2015 Transparency Exercise were to
switch all their current holdings of euro-area sovereign bonds into senior SBBS tranches
today (so without an "enabling" regulatory framework in place), they would face an
increase in aggregate capital requirements in the order of EUR 70 billion (see Annex 4,
Section 1). Of course, this is just a gauge, and less extensive switches would result in
correspondingly lower capital requirements. At the same time, if banks also bought sub-
senior tranches, which currently would face much higher risk weights than senior ones,
the capital requirement implications could also be much larger.
These hurdles are likely to remain even after taking into account some regulatory
changes which are already in the pipeline, e.g. those stemming from the recent revision
of the securitisation framework (Regulation (EU) 2017/2401), due to become effective
on 1/1/2019. Regulation (EU) 2017/2401 foresees reduced capital requirements on
securitisation positions for banks provided they are at all moments perfectly informed
about the composition and risk features of the underlying assets—this condition is likely
to be easily satisfied for SBBS (especially if the latter have a narrowly defined
"recipe"—see below). Nevertheless, the subset of banks using the Standardised Approach
30
The problem of how to ensure compliance with a legislation that dictates a specific treatment for a subset of
securitisations has already been addressed in the context of the regulation on Simple, Standard, and
Transparent securitisations (STS). Thus a similar approach will be used here.
20
(henceforth, "SA banks") would still face large capital requirements when holding
sub-senior tranches under the baseline after 1/1/2019. Section 2 of Annex 4 shows that,
for each EUR 100 billion of investment in SBBS, assuming SA banks purchase the three
tranches in a balanced manner and in line with their current share of sovereign bonds in
the banking book, aggregate risk-weighted assets would increase by some
EUR 87 billion (this number would need to be multiplied by a capital requirement ratio,
typically in the range of 8-13 percent, to arrive at the implications of the investment in
SBBS for capital requirements).
Against this baseline, the alternative option is to intervene by proposing an "enabling"
regulatory framework that adequately reflects the unique nature of securitisations issued
against a portfolio of euro area sovereign bonds. This option can take different
declinations, depending on the desired extent to which SBBS are equated—in terms of
regulatory treatment31
—to their underlying components (i.e. euro-area sovereign bonds)
and on how precisely one goes about designing any such desired regulatory treatment in
practice.
In his Letter of Intent accompanying his September 2017 State of the Union Address to
the European Parliament, President Juncker has committed the European Commission to
introduce an "enabling framework" for SBBS, in other words to move past the baseline
of no intervention.
This course of action is dictated by the potential benefits associated with the concept of
SBBS. Although whether or not SBBS, once freed of existing regulatory impediments,
will actually take off is difficult to predict, the fact remains that the benefits, in expected
terms (i.e., weighted by the probability of them actually materialising), that would stem
from the development of a market for SBBS far outweigh the cost of introducing the
enabling framework.
Aside from the one-off direct costs of introducing the product regulation (which, it bears
recalling, in effect recalibrates existing regulations to allow for a completely new
product), other possible costs would stem from "unintended consequences" of a
developed SBBS market. Importantly, when assessing such possible costs and risks, one
has to distinguish between those which result (or are intensified) directly by the existence
of SBBS in financial markets, from those that would happen as a reflection of
developments in the fundamentals of the underlying sovereign bonds, which would likely
affect SBBSs but that would occur regardless of whether SBBS are in the market or not.
For the latter set of costs/risks, the relevant yardstick of comparison is whether the
presence of SBBS aggravates them or not.
In the former category (i.e., risks stemming directly from the development of SBBS
markets), the key one considered both by the HLTF and for this impact assessment has to
do with the possibility (flagged, in particular, by euro-area Debt Management Offices)
that packaging a lot of a given government's bonds into SBBS could adversely affect the
31
Note that extending the regulatory treatment of euro-area sovereign bonds to any given SBBS tranche would
be tantamount to addressing, for that specific tranche, all dimensions of currently differential treatment as
described in Box 4.
21
liquidity of the bonds of said government that remain outside of the SBBS construct. The
HLTF has analysed at length the likely effects of SBBS on the liquidity of national
sovereign debt markets and it has concluded that, certainly for moderately-sized volumes
of SBBS, these are likely to be limited (see, in particular, Volume II, section 4.4 of the
ESRB HLTF report and Annex 4.3 of this impact assessment).
In the latter category (i.e., risks that stem from possible developments in the
fundamentals of underlying sovereign bonds, e.g. causing the loss of the AAA rating for
the senior SBBS tranche), the key question is whether, in a crisis circumstance, the
presence of SBBS is stabilising or destabilising. Note that it is quite possible that, during
an episode of turbulence linked to marked deterioration in the creditworthiness of one or
more euro area sovereigns, it may become difficult or even impossible to assemble
SBBS, presumably because there will be no demand for the junior tranche in those
circumstances. (In extreme circumstances, the senior tranche might also be downgraded).
But this would still leave those sovereigns who do remain creditworthy able to issue their
own bonds, while for the others the problem would not be different than if SBBS had
never been created. Even if volume of SBBS (temporarily) stops growing in such a
circumstance, the stock of already issued SBBS may still prove helpful in channelling
financial flows from across national borders (as happens at present, with investors fleeing
Member States in trouble and seeking safe haven in "core" Member States) to a
"cross-instrument" pattern (i.e., from the junior to the senior tranches). This would be
less damaging to the integrity of the euro area. Moreover, bonds packaged in the already
issued SBBS would not be "available for sale", which would in itself provide some
stabilisation ("fire sale"-driven spikes in individual Member States' funding costs would
be avoided).
Others have argued against an enabling regulatory framework on the ground that the
product is not viable. For instance, no private issuer may deem SBBS to be sufficiently
profitable, or there may not be sufficient demand for the junior tranche. In our view, this
is no grounds not to rectify the identified regulatory "failure". Rather, it would just
indicate that the above-mentioned "market test" would not have (yet) been successful.32
On the basis of the above arguments, this assessment concludes that the Commission has
no option but to propose an "enabling framework" and that indeed doing so generates, in
expected terms, a net social gain. Section 5.2 describes the intervention options
considered, while section 5.3 describes options which have been discarded after careful
consideration.
32
Once regulatory impediments have been eliminated, demand (and thus the development of the SBBS market)
could still take place in the future if, say, the overall euro-area/global macroeconomic environment turns
more supportive.
22
5.2. Description of the policy options
Option Description
1. Scope of applicability of the proposed legislation
1.1 Only SBBS proper Only securitisations of euro-area sovereign bonds that comply
with the SBBS recipe (see Box 6), i.e. whereby the underlying
portfolio comprises all euro-area sovereign bonds with respective
weights in line with the ECB capital key (rebased, as necessary, to
exclude Member States that either have no or too little
outstanding debt or might have lost market access) and which
have tranching levels such that the senior tranche is "low-risk"
(e.g., the senior tranche is not greater than 70%)33
.
1.2 All securitisations of
euro-area sovereign
bonds
Any securitisation of euro-area sovereign bonds, regardless of the
composition of the underlying portfolio and/or the number and
levels of tranches, would be eligible for the regulatory treatment
envisaged in the proposed product legislation.
1.3 A basket of euro-area
sovereign bonds (no
tranching)
Claims on an investment fund which invests fully in a basket of
euro-area sovereign bonds, with respective weights in line with
the ECB capital key (rebased, as necessary, to exclude Member
States that have no outstanding debt and those who have lost
market access), without tranching.
2. Extent of "restored" regulatory neutrality
2.1 Extend the regulatory
treatment of euro-
area sovereign bonds
to all tranches
All tranches of the products eligible for the proposed legislation
would be given a treatment comparable to that of euro-area
sovereign bonds (in particular, no capital requirements, level-1
eligibility for LCR/NFSR purposes, no concentration
charges/limits, no investment restrictions.
2.2 Extend the regulatory
treatment of euro-
area sovereign bonds
only to senior
tranches
Only the senior tranche of the products eligible for the proposed
legislation would be given a treatment comparable to that of euro-
area sovereign bonds (in particular, no capital requirements, level-
1 eligibility for LCR/NFSR purposes, no concentration
charges/limits; no investment restrictions). Sub-senior tranches
would, instead, have additional charges, liquidity discounts,
concentration charges, and investment limits.
3. Compliance mechanism
3.1 Introduce a self-
attestation
mechanism
Responsibility for compliance with the criteria envisaged in the
legislation will lie with the originator of the securitisation.
3.2 3.1 + third-party
assessment
Self-attestation by the originator, complemented by assessment
provided by an independent third party.
3.3 3.1 + ex-ante
supervisory approval
Self-attestation by the originator, complemented by ex-ante
supervisory approval.
33
See footnote 9 for an explanation of how the 70% threshold is arrived at in the HLTF report.
23
5.3. Options discarded at an early stage
Regulatory incentives
In addition to the options set out above and discussed in more detail below, a related but
different one has been considered, namely going beyond the mere levelling of the
regulatory playing field for SBBS by providing them the same treatment as for sovereign
bonds, to actually providing them a preferential regulatory treatment (i.e., outright
regulatory incentives).
The main advantage of such approach is that the demand for SBBS would be
correspondingly boosted and the potential benefits of SBBS would materialise faster and
at a larger scale.
There are two main drawbacks, however. First, using the regulatory framework to the
advantage of this new product could, at least in a transition phase, destabilise (some)
national debt markets, as demand for SBBS might replace, rather than complement,
demand for stand-alone national sovereign bonds. Second, regulatory incentives could be
seen as a signal that the Commission, and more generally the European authorities, stand
ready to bail out investors, should these novel structured products encounter problems.
Such expectations would be highly detrimental, as they could lead to moral hazard on the
part of Member States and of investors.
On the basis of the above considerations, such an option has been discarded. The
proposed legislation would aim at treating SBBS as much as possible as euro-area
sovereign bonds (i.e., restore "regulatory neutrality"), but not better/more favourably.
Public issuance
A second option, discarded after careful consideration, is that of a public issuer/arranger
for SBBS (this could be either an existing institution, such as the ESM, or a newly
created public SPV). A public arranger could benefit from economies of scale (which
would ease the viability test for SBBS) and may meet greater confidence from market
participants from the very start. However, entrusting a public authority with such task
would shift a well-established private-sector activity to the public sector. This might also
mean that the possible link and synergies of such activity with that of (private-sector)
market-making of government bonds could not be reaped.
Furthermore, deploying a public issuer could also result in some mutualisation of risks
(for example, in terms of warehouse risk for any period between the assembling of the
SBBS portfolio and the selling of all the tranches), which could result in moral hazard
(this concern has been raised by several observers/stakeholders, including Debt
Management Officers—see Annex 2). Also, a public arranger would need some funds
(for example a one-time fixed endowment of a limited quantity of paid-in capital) for the
purpose of assembling SBBS cover pools. Providing a public arranger with any public
funding or support may increase the risk that market participants misperceive such
activity as providing an implicit guarantee for SBBS payment flows.
24
On the basis of the above considerations, such an option has been discarded. The
proposed legislation would aim at removing the impediments for private sector
production/use of SBBS. Once again, it bears reminding that removing the identified
regulatory impediments enables the development of this novel private financial
instrument, but in no way guarantees it. It may well be the case that, quite aside from the
regulatory framework, assembling SBBS will prove too costly/insufficiently
remunerating for the private sector. The viability of SBBS might also be a function of the
more general economic backdrop, e.g., the level of interest rates and/or expected fiscal
and real developments.
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS?
6.1. Scenarios and benchmarks of benefits and costs
6.1.1. Scenarios
To cater for a wide range of possibilities, the impact of different intervention options has
been assessed under two different scenarios: a limited volume scenario, whereby SBBS
reach an overall volume of EUR 100 billion, and a steady state scenario whereby SBBS
reach an overall volume of EUR 1,500 billion.34
The final scale of the SBBS market will
depend on the instruments' overall attractiveness for the market, given that the legislative
intervention is only a necessary but not necessarily sufficient condition for SBBS's
development.
6.1.2. Benchmarks of benefits and costs
As regards the choices with respect to the scope of applicability of the proposed
legislation (section 6.2 below) and the extent to which the regulatory treatment afforded
to euro area sovereign bonds (henceforth, "benchmark" regulatory treatment) is also
provided to the various SBBS tranches (section 6.3 below), the following benefits and
costs have been assessed:
- reduction in capital requirements (benefit);
- reduction in liquidity of national sovereign debt markets (cost);
- impact on volume of sovereign bonds rated AAA (benefit/cost);
- reduction in holdings of domestic sovereign bonds (benefit);
- impact on share of sovereign bonds rated AAA in banks' balance sheets
(benefit/cost);
- facilitating cross-border integration and the reduction of asymmetric shocks
(benefits).
The benchmarks used are the evolution in % compared to the baseline scenario (current
situation), or the amount of regulatory hindrance faced in the baseline (no intervention)
by SBBS instruments, except for the liquidity of national debt markets as well as the last
34
Both scenarios are considered in the HLTF report. In particular, as regards the steady state scenario, the HLTF
considers an amount of EUR 1,500 billion as indicative of the size that an SBBS market could achieve while
maintaining an adequate secondary market free float in national sovereign bond markets.
25
criteria (integration of capital flows cross-border), where the analysis remains mainly
qualitative.
For the third key choice, i.e., the certification model (section 6.4 below), the main benefit
to be assessed is the increased investor confidence while costs include both the potential
moral hazard and the administrative burden for stakeholders. The assessment remains
mainly qualitative for that option.
6.2. Scope of applicability of the proposed legislation
This section describes and assesses the scope of applicability of the product legislation,
i.e. the range of sovereign bond-backed securities to which the legislation would apply.
The two polar options are, thus, applying the proposed product legislation to any
securitisation of sovereign bonds, or only to a particular combination of sovereign bonds
(whether tranched or in a "simple" basket).
6.2.1. Option 1.1: only SBBS proper
Option 1.1 deals with one extreme, where the legislation would be made applicable only
to SBBS proper, i.e. securitisations of euro area sovereign bonds which meet the official
"SBBS recipe".
Box 6: The SBBS structure
A set SBBS structure (i.e., a methodology to assemble SBBS), e.g. a fixed portfolio of euro area
sovereign bonds with known weights (e.g., in line with the ECB capital key—see Box 1) and
specified tranching points, is helpful to create a standardised product, which in turn enhances the
product's appeal (e.g., in terms of liquidity).
However, there may be circumstances in which some changes in this set structure are warranted.
For example, an EU Member State may join the euro area. Or a Member State issues too little
debt, so that it becomes difficult if not altogether impossible for arrangers to acquire the
necessary amount of bonds of that Member State as prescribed by the current structure. Or it may
be necessary (respectively, possible) to reduce (resp., increase) the size of the senior tranche if
the ratings of the underlying euro area sovereign bonds deteriorate (resp., improve).
For such exceptional cases the regulatory framework should foresee safeguards, which allow for
controlled and limited modifications of the set SBBS structure. The trade-off is between adapting
the product to the changed reality and safeguarding standardisation. Efficiency will likely call for
minimizing the changes to the set structure as much as possible.
Who would set the SBBS structure and through what procedure would it be changed?
There are in principle three avenues:
1. A public agency (e.g., ESMA) could be tasked, in the enabling regulation, to spell out the
initial SBBS recipe and to propose adjustments to it when necessary. These proposals would
be akin to regulatory technical standards, which are approved by the Commission.
2. The Commission itself could define and adapt the official SBBS recipe by way of
Implementing Decisions.
3. Alternatively, a private entity (e.g., a consortium of arrangers) could set out, and change as
appropriate, the "standard" for the SBBS product.
These avenues will be explored in the drafting of the legislative proposal, with a view to
maximize the likely chance of success of the product (including by underpinning market
confidence and legal certainty, e.g. with respect to its eligibility for the proposed regulatory
treatment) and minimize administrative burden.
26
Should the product legislation apply only to SBBS proper, thanks to the ensuing induced
standardisation, a sizeable market for this particular instrument is likely, although by no
means certain, to develop. This, in turn, could enhance liquidity and appeal of the new
instrument, and provide greater incentives for banks and other financial institutions to
invest in them. This prospect in itself may be an important factor in generating sufficient
demand. So, a narrower scope of applicability of the proposed legislation may be
’enabling’ in and of itself, as far as the ultimate development of SBBS is concerned (see
responses to the public survey on liquidity and standardisation in Annex 2, section 1).
One critical feature of the SBBS proper is the tranching of the instrument which should
ensure that the senior tranche is granted a AAA rating (note that this may require
adjusting the size of the tranche over time in response to future economic, financial and
political developments – see Box 6). Assuming the senior tranche at a 70% tranching
point is granted a AAA-rating (i.e., is considered as safe as the safest assets in
circulation), the Commission's analysis (see section 4 in Annex 4) shows that the
introduction of the SBBS could increase the volume of AAA sovereign bonds available
in the euro area by some 2% (in the limited volume scenario) and up to 30% (in the
steady state scenario) compared to the baseline with no legislative initiative and thus no
SBBS.
Under this option, the impact on the diversification of banks' sovereign portfolios would
range from a reduction by 3% of domestic sovereign holdings to a reduction of those
holdings by 34%, depending on the scenario (limited volume vs steady state scenario).
Similarly, the share of government bonds rated AAA on banks' balance sheets would
increase by about 40% under the steady state scenario (from 24% to 32% or 33%
depending on the regulatory treatment), but remain roughly unchanged under the limited
volume scenario (see section 4, Annex 4).
A key concern raised by several stakeholders is that SBBS might adversely impact the
liquidity of national sovereign debt markets. These concerns are the more relevant the
smaller the national sovereign bond market (this is, e.g., in particular the case for small
Member States) and the larger the overall volume of SBBS. Given the importance of
such concerns, the HLTF has conducted an in-depth analysis, which is summarised in
Section 3, Annex 4. The main conclusion is that the ultimate impact on the liquidity of
the national sovereign bond market results from two opposing channels: On the one
hand, as the size of SBBS market increases, the liquidity for the remaining national
bonds outside the SBBS scheme could suffer because of the reduction in the residual
outstanding float. On the margin, this could lead to higher funding costs for the most
affected Member States and a hampered price discovery process.35
On the other hand,
SBBS might attract additional demand for national sovereign bonds, and thereby add to
their liquidity (this is especially true for those sovereigns that are not typically in the
radar screen of large global investors—which is also often the case for smaller Member
States). SBBS portfolios would also support prices, and thus be liquidity-enhancing—as
bonds included therein could not be sold abruptly in episodes of turbulence.
35
For this reason, as has been done for example for the ECB's Public Sector Purchase Program, caps could be
envisaged on the share of outstanding sovereign bonds of individual Member States that can be used for
SBBS.
27
The impact of option 1.1 on different stakeholders depends on different factors, such as
the regulatory treatment of the SBBS tranches (see options 2.1 and 2.2) and the market
size SBBS would ultimately achieve. Annex 3, Table 7 and Table 8 give some overview
of expected impacts compared to the benchmark scenario (in particular for models 1
and 2). For banks, other investors and arrangers the impact is expected to be (very)
positive given the availability of a new standardised and profitable product. For
supervisors, administrative expenses will depend on the model chosen for ensuring and
monitoring compliance (see section 6.4). They may be larger if a certification of each
issuance is required compared to the self-certification option. But in any case these
expenses are likely to remain small (since all that would be required would be monitoring
compliance of the underlying portfolio with the ECB capital key and that the tranching
levels are appropriate) and to be outweighed by the enhanced stability of the financial
system from greater diversification in banks' sovereign portfolios and weakened bank-
sovereign nexus. As discussed above, some national sovereign bond markets could be
adversely affected in terms of residual floating stock of debt, but these effects would
materialise only if SBBS reach a truly large scale and could in any case be
counterbalanced by the increased demand for such bonds.
Neither option 1.1, nor any of the other options discussed below, is expected to impact
directly on retail investors, households or SMEs, because they would unlikely be active
in SBBS markets. At the same time, these sectors would benefit indirectly—including
from enhanced confidence—to the extent that the above-mentioned macroeconomic and
financial-stability benefits materialise.
Neither option 1.1, nor any of the other options discussed below, is expected to have a
direct social impact, environmental impact or impact on fundamental rights.
6.2.2. Option 1.2: All securitisations of euro area sovereign bonds
Option 1.2 envisages that the legislation is made applicable to any securitisation of
sovereign bonds, or at least of those sovereign bonds that are actively traded. After all,
the economic considerations as to why otherwise such securitisations would stand no
chance of being produced and demanded have a rather general applicability.36
This option would thus provide the widest possible scope of applicability of the
legislation, and would also maximize the scope and flexibility for economic agents to
take advantage of securitisation techniques to better share and allocate euro-area
sovereign risk. It may also simplify the necessary market infrastructure, e.g., in terms of
ascertaining/certifying eligibility of any candidate securitisation for the product
legislation, thus minimising administrative and other costs (more on this in section 6.4
below).
The disadvantage of Option 1.2 would be that it is unlikely that any given securitisation
of sovereign bonds, among the infinite possible varieties, would become prominent or
established in the market, and thus gain the role and carry out the functions of a liquid
benchmark security. Yet, liquidity is clearly an essential feature for any security to be
36
At present, EU banks can, for example, apply zero risk weights to their holdings of any and all EU sovereign
bonds denominated in the sovereign's own currency.
28
appealing for investors to hold, in particular for securities which are closely related to
sovereign bonds—the benchmark "safe assets" par excellence for investors (see Annex 2,
in particular the responses to the public survey on liquidity in section 1, the summary of
the Industry Workshop in section 2, and the summary of the dedicated DMO workshop
in section 3). Unless these new securitisation products acquire sufficient liquidity, it
would for example be unlikely that banks would hold them in lieu of their current (liquid,
but often too concentrated) holdings of sovereign bonds.37
For the same reason, the extent to which this option would generate a product with net
benefits accruing uniformly across euro-area Member States is unclear. It would depend
on the products that would actually be launched in the market and on which ones (if any)
become more commonly used over time.
The impact of option 1.2 on the volume of AAA assets and on the composition of
sovereign portfolios on banks' balance sheets would greatly depend on the structure of
the products issued and purchased by banks. However the expected lack of liquidity for
those products probably prevents their wide dispersion, so that the related impacts
(compared to the baseline scenario) are expected to be small.
The impact of option 1.2 on different stakeholders depends on different factors, such as
the regulatory treatment of the various tranches (see options 2.1 and 2.2) and the market
size they would ultimately achieve. Overall, the impact on banks and other investors may
be positive or neutral, as new products become available, although their attractiveness is
questionable given their lack of standardisation and ensuing likely lack of liquidity. The
impact on arrangers is expected to be positive or neutral, depending on the profitability of
the product and the market size. For supervisors, the impact crucially depends on the
market structure and is difficult to predict ex-ante. As regards the impact on national
sovereign bond markets, the impact depends mainly on the size/attractiveness of these
new products. The bigger their market, the more they become a competing product for
sovereign bonds and may affect sovereign bond market liquidity. At the same time,
funding costs could be positively affected though reduced bank-sovereign nexus risks.
See Annex 3 (in particular models 3 and 4) for further details.
6.2.3. Option 1.3: A basket of euro-are sovereign bonds (with weights
according to the official "SBBS recipe")
Option 1.3 concerns making the legislation applicable to a specific portfolio of sovereign
bonds, i.e. one whose individual weights are in line with the official "SBBS recipe" as
presented in Box 6 (so this portfolio would be the same as that used for SBBS, but
without tranching). In what follows, such a product will be referred to as the "basket".
Restricting the applicability of the proposed legislation only to this basket, as opposed to
any basket, is in the interest of facilitating, through standardisation, the emergence of a
benchmark liquid asset.
Functionally, this basket would be equivalent to a securitisation with a single tranche.
However, from a regulatory point of view it is not a securitisation, as there is no
37
Therefore providing such a wide range of securities with benchmark treatment in terms of regulatory liquidity
may well be unwarranted.
29
tranching element when constructing the product, which is one of the two defining
features of securitisation. The other defining feature is the pooling of various types of
contractual debt. This means that it may not suffer from the same regulatory hindrances
faced by securitisations of sovereign bonds.
The actual treatment of a claim on this basket in the baseline would depend on the
specifics of the setup. Such ‘claims’ at present may take different forms (e.g., they could
be covered bonds, corporate bonds, or units in a Collective Investment (so called
Collective Investment Units or CIUs)). Their regulatory treatment, including eligibility
for an application of the ‘look through’ principle as far as CRR-driven capital
requirements, may vary accordingly.
Even though under the proper setup (i.e. as CIUs) investments in this basket may not face
unfavourable treatment in terms of capital requirements, they are still likely to face other
hindrances, especially in terms of no or incomplete eligibility for liquidity coverage
requirements (LCR).38
Thus an enabling framework would need to tackle at least these
constraining factors and could result in a standardisation of these claims (which would all
be structured to benefit from the regulatory treatment granted by the enabling
framework).
As for Option 1.1, if the product legislation would apply only to this basket (as opposed
to any conceivable basket of euro area sovereign bonds), a sizeable market for this
particular instrument is more likely to develop, thanks to the induced standardisation,
although again by no means certain. Thus, also in this case a narrower scope of
applicability may be more ’enabling’ than a wider one.
As for SBBS proper (option 1.1), this basket is by construction a product whose net
benefits would accrue to all euro-area Member States. Through it, Member States that
have a small and relatively illiquid sovereign debt market may be able to tap additional
demand. A well-developed market for such basket could also favour a more uniform
repercussion on national funding conditions from exogenous increase (say, from outside
the euro area) for euro area exposure. This would be positive for Member States that
would otherwise not benefit from this enhanced demand for euro exposure, but it is also
good for the high-rated Member States, which until now serve as "safe havens" in a
crisis, leading to higher fluctuations in their government debt interest rates and unduly
low interest rates that could lead to overheating, misallocation of investment, and to
challenges for some investor classes (e.g., pension funds).
As there is no tranching, this basket only provides diversification of risk, which on its
own is insufficient to generate a low-risk asset. We estimate that this basket would
reduce the amount of domestic bonds held by banks in a range of 3% to 34% compared
to the baseline scenario, depending on the scenario (limited volume versus steady state)
analysed (see section 5, Annex 4).
38
If structured as shares in a CIU, investments in a basket (option 1.3) would, per Article 15 of the LCR
Delegated Regulation, be eligible under certain conditions to the LCR buffer up to a maximum amount of
EUR 500 million (the amount is limited as this is a deviation from Basel intended for small credit
institutions) with a 0% haircut (as the underlying assets are government bonds), provided they respect the
general and operational requirements to be included in the buffer (amongst which historical liquidity).
30
Although this basket would exhibit much lower price volatility than individual
government bonds, its credit risk would be higher than that of many individual sovereign
bonds. The rating of such basket is not expected to be the highest possible ("AAA" in the
terminology of major credit rating agencies), with the immediate consequence that the
overall amount of AAA-rated sovereign bonds available in the euro area would sharply
decrease in the market (-25%) if such baskets were to reach a significant market size
(e.g., in the envisaged steady state scenario). In the limited volume scenario, the effect
would be smaller (-3%) (see section 4, Annex 4). In fact, assets based on this basket
would be riskier than the current portfolios of most banks.39
Inducing greater
diversification could therefore increase the total exposure of banks to sovereign risk for a
given volume of sovereign debt holdings. It is estimated that in the steady state scenario
the share of sovereign bonds rated AAA on banks' balance sheets could decrease from
24% to 19% for euro area banks (see section 4 in Annex 4). However, conversely, the
share of rather lower-rated government bonds would also decrease.
The effects of the development of a market for such a basket instrument on the liquidity
and funding conditions on national sovereign bond markets presents the same
opportunities and challenges as discussed for Option 1.1 above.
Given the specificities of this basket, the impact of option 1.3 on different stakeholders is
expected to be neutral or unclear (see also Annex 3). While there could be a positive
effect for banks, other investors and arrangers given the availability of a new
standardised product, its overall profitability is questionable. As for options 1.1 and 1.2
the impact on supervisors crucially depends on the market structure and is difficult to
predict ex-ante. The effect on DMOs and sovereign bond market liquidity is comparable
to the one of option 1.1.
6.2.4. Impact summary and conclusions
The main considerations weighing in favour or against the three options considered in
this subsection are summarised in Table 1 below.
Overall, while conceptually all securitisations and baskets of sovereign bonds would face
some kinds of regulatory hurdles, it may be preferable to specifically adapt the regulatory
framework only for one specific securitisation and one specific basket, e.g. those issued
against a portfolio respecting the "SBBS recipe" as described in Box 6 (as is the case for
the SBBS proper). This would enhance the likelihood that a structured product of euro-
area sovereign bonds becomes sufficiently traded so as to gain "benchmark"-type appeal.
39
See section 2.2 of Volume 1 of the HLTF Report.
31
Table 1: Option 1 (scope of applicability): summary assessment
6.3. Extent of ’restored’ regulatory neutrality
This section assesses whether regulatory neutrality should apply to all tranches or only to
the most senior one, i.e. whether the most favourable regulatory treatment (currently
applicable to each and every component of the underlying portfolio of sovereign bonds)
should also apply to the whole SBBS instrument. This issue does not concern the basket
(option 1.3), as there is only one ‘tranche’, or only one type of security (which is either
given equal regulatory treatment to EU sovereign bonds or not).
Consider, for example, the determination of capital requirements associated with banks'
investments in tranches of a securitisation of sovereign bonds. In this case, complete
regulatory neutrality would require setting a zero risk weight for all tranches.
Alternatively, one could give the zero risk weight only to the senior tranche40
and
positive risk weights to the sub-senior tranches, e.g. in proportion to their relative
(estimated) risk/volatility. In this case, regulatory neutrality would remain incomplete:
the regulatory playing field with euro-area sovereign bonds would become level for
senior tranche, but not for sub-senior ones.
Similar considerations could be made as regards other key aspects of legislation. For
example, one could decide to grant the same regulatory status of sovereign bonds, i.e. full
eligibility (with no haircuts) for level-1 treatment in the determination of compliance
40
Feedback from market participants has confirmed that a zero risk weight is essential for the senior tranche—
which, by virtue of its enhanced safety, is likely to have a very low yield—to be attractive for banks,
including as an alternative to holding (concentrated) portfolios of sovereign bonds.
Specific Objectives Option 1.1 Only SBBS proper
Option 1.2. All securitisations of euro
area sovereign bonds
Option 1.3 A basket of euro-are
sovereign bonds with weights in line
with ECB capital key
Ensure regulatory
playing field between
the asset and the
underlying
government bonds
(++) It addresses the identified
regulatory issues for the SBBS product.
(++) The issues arising when the
securitisation framework is applied to
securitisations of sovereign bonds are
addressed in a comprehensive manner.
(+) Gives maximum flexibility to market
participants as how to use
securitisation techniques to better
manage risk associated with
fluctuations in perceived
creditworthiness of euro area
sovereigns
(+) It addresses any regulatory issues
for the basket.
Facilitate liquidity and
benchmark quality of
the asset
(++) the narrow applicability of the
product regulation could help ensure
that all issuers of these new products
pool and tranche euro area sovereign
bonds in the same way. This would
contribute to the emergence of a
standardised product, which could
underpin greater liquidity and appeal,
including as a "natural" way for non-
euro area investors to gain euro-
denominated (low) risk exposure.
(-) the general applicability of the
product regulation would reduce the
likelihood that a (finite number of)
securitisation product(s) would emerge
as "benchmarks". This may limit the
extent to which individually any such
product would be seen as a liquid
asset. (-) Moreover, many
securitisations could combine
sovereign bonds with varying credit
ratings, without any particular criterion.
This would per se lower the "brand"
value of the product class.
(+) To the extent that the proposed
regulation would offer a more
favorable treatment to this particular
basket, it may incentivise issuers of
baskets of government bonds to pool
euro-area sovereign bonds in the same
way. This would contribute to the
emergence of a standardised product.
32
with liquidity-based requirements (such as LCR and NFSR), to all tranches of a
securitisation of sovereign bonds, or alternatively only to the senior tranche.
The considerations in favour of the former or the latter approach are discussed next.
6.3.1. Option 2.1: Extend the regulatory treatment of euro area sovereign
bonds to all tranches
Option 2.1 extends the regulatory treatment of euro-area sovereign bonds to all tranches
of an SBBS, which restores ’full neutrality’.
Full neutrality would maximize the ’enabling’ effect of the legislation:
1) From the perspective of capital requirements, assigning zero risk weights to all
tranches would, for example, allow banks to hold any given fraction of their
aggregate portfolio of euro-area sovereign bonds in the form of these tranches,
without facing additional capital requirements.
2) From the perspective of liquidity coverage requirements, full eligibility for
LCR/NFSR purposes for all tranches—would be more ’enabling’ than any other
alternative regulatory status because it would ensure that the development of an
SBBS market does not trigger a (regulatory) liquidity ’squeeze’. To understand why
this is the case, consider that at present all euro-area sovereign bonds are fully eligible
to meet the liquidity requirements (they are, in technical terms, level-1 High-Quality
Liquid Assets, or HQLA). If all tranches of a securitisation are also made eligible for
level-1 HQLA, then the supply of HQLA would not change regardless of the amount
of euro area government bonds which are assembled into these new securitisations
(that is, regardless of the volume of these new instruments).
Regarding the benefits and costs in terms of availability of AAA-rated sovereign bonds
and composition of sovereign portfolios on banks' balance sheets, the impacts are similar
to those described in section 6.2 for the SBBS proper (option 1.1) and would depend on
the scenario. In particular, in the limited volume (respectively, steady state) scenario, the
volume of AAA sovereign bonds in the euro area would increase by 2% (respectively,
30%), banks' holdings of own-sovereign bonds would decline by 3% (respectively, 34%),
and the share of AAA bonds in banks' sovereign portfolios would increase by 24%
(respectively, 32%) (see Annex 4, sections 4 and 5).
The impact of option 2.1 on different stakeholders depends on different factors, such as
the scope of applicability of the proposed legislation (see options 1.1 and 1.2) and the
market size SBBS would ultimately achieve. Overall, the positive impact on banks, other
investors and arrangers given the minimised regulatory charges may be greater if
standardisation of the product was guaranteed. As for the options discussed above, the
impact on supervisors crucially depends on the market structure that develops. As regards
the impact on DMOs, the impact depends mainly on the size/attractiveness of SBBS as
well as the structure of the national sovereign bond market. Some national sovereign
bonds may be affected more than others and the bigger the size of the SBBS market, the
larger the possible implications for national sovereign bonds. See Annex 3 (in particular
models 1 and 3) for further details.
33
6.3.2. Option 2.2: Extend the regulatory treatment of euro area sovereign
bonds only to senior tranches
Option 2.2 extends the regulatory treatment of euro-area sovereign bonds only to the
senior tranche of a securitisation.
In this case the proposed legislation would be less ’enabling’ and would (by design) level
the regulatory playing field only up to a point, i.e. only for the senior tranches.
Under this scenario, any switch by banks from direct holdings of sovereign bonds to
tranches of securitisations of sovereign bonds would result either in increased capital
requirements, or in banks having to sell off the part of their sovereign exposure
equivalent to the sub-senior tranches to keep their capital requirement unchanged. Either
way, the perceived risks faced by banks would have declined, or countered with greater
loss absorption capacity (see also Annex 3 for estimates of the impact on banks). This in
itself would be positive for financial stability considerations.
As regards government funding costs, the effects of incomplete regulatory neutrality
would depends on banks' reaction (in particular, on the extent to which banks switch their
current sovereign bond holdings into these new products), on the elasticity of supply of
bank (equity) capital, and on the elasticity of the demand by other investors for any
sovereign risk divested by banks. For example, the impact on funding costs would be
reduced, and in the limit disappear, if other investors that are not subject to capital
requirements would readily purchase sub-senior tranches sold by banks. Member States
with higher debt would be more affected by any increase in their funding costs.
Similarly, if junior tranches were not made fully eligible for HQLA status when it comes
to compliance with LCR/NFSR liquidity requirements, then the greater the amount of
such securitisations which is assembled, the larger the effective reduction of
HQLA-eligible securities available to market participants,41
which may result in
increased price for residual HQLA securities (i.e., a reduction in interest rates) and/or in
pressures for banks to increase the liquidity of their other assets (e.g., scaling down their
maturity transformation activities).
Regarding the benefits and costs in terms of availability of AAA-rated sovereign bonds
and composition of sovereign portfolios on banks' balance sheets, the impacts are similar
to those describes for option 2.1, except than the share of AAA bonds in banks' sovereign
portfolios would reach 33% under the most optimistic scenario (see Annex 4, sections 4
and 5).
As for option 2.2, the impact of option 2.1 on different stakeholders depends on different
factors, such as the scope of applicability of the proposed legislation (see options 1.1 and
1.2) and the market size SBBS would ultimately achieve (see Annex 3). As indicated
above, a more risk-sensitive treatment of the non-senior tranches would contribute to
making the overall financial system more stable. Thus the impact on supervisors is
41
Of note, and in contrast to what happens for example with the ECB's purchase programs, sovereign bonds
underpinning a securitisation would not be envisaged to be lent out for liquidity/collateral purposes—they
would be effectively withdrawn from the market as far as the total supply of HQLA is concerned.
34
expected to be positive. The impact on DMOs/sovereign bond market liquidity is unclear
depending on different variables but is overall expected to be limited (see Annex 4,
section 3).
6.3.3. Impact summary and conclusions
The considerations militating in favour of full neutrality for all tranches versus full
neutrality only for senior tranches are summarised in Table 2 below.
On balance, levelling the regulatory playing field for all tranches maximizes the enabling
nature of the proposed product legislation, and would also minimize any capital
requirement or liquidity squeeze that would result, especially in the presence of a large
switch in banks' portfolios out of direct holdings of sovereign bonds and into such
tranches. At the same time, especially for sub-senior tranches, some discrepancy might
emerge between, for example, the granted HQLA status in terms of liquidity
requirements and the actual market liquidity exhibited by the security.
Table 2: Option 2 (extent of restored regulatory neutrality)—summary assessment
6.4. Ensuring compliance with SBBS criteria and consistency in
implementation42
This section describes and assesses three policy options to ensure that any given financial
instrument complies with the eligibility criteria specified in the product legislation. This
42
Given the similarities of the issues at stake, this section draws on the impact assessment of the STS regulation
at: https://ec.europa.eu/info/publications/impact-assessment-accompanying-proposals-securitisation_en
Specific Objectives Option 2.1. Extend the regulatory treatment of
euro area sovereign bonds to all tranches
Option 2.2. Extend the regulatory treatment of
euro area sovereign bonds to senior tranches only
Ensure regulatory playing field
between the asset and the
underlying government bonds
(+) All the regulatory hindrances to the
development of markets for securitisations of
sovereign bonds are removed.
(+) The enabling nature of the regulation is
maximized, since the capacity to offer senior
tranches also depends on the demand for sub-
senior tranches (the issuers are not supposed to
retain any risk associated with their securitisation
activities)
(+) The senior tranches are given "benckmark
quality" regulatory treatment, thus ensuring them
a level-playing field with the underlying sovereign
bonds. Moreover, the differential treatment may
underscore their added safety.
(+) More "prudent" treatment of sub-senior
tranches--particularly important if the securitised
portfolio is not sufficiently diversified or heavily
exposed to low-rated sovereigns.
(-) Demand for sub-senior tranches may be less
forthcoming, especially from banks.
Facilitate liquidity and benchmark
quality of the asset
(+) No capital requirements and liquidity pressures
resulting from any switch by banks from direct
sovereign bank holdings to tranches of
securitisations of sovereign bonds--banks'
incentive to switch is maximized.
(+) No aggregate "liquidity squeeze" that would
result if assembling securitisations of sovereign
bonds would reduce HQLA level-1 eligible assets.
(-) A mismatch might emerge between the
regulatory treatment of a securitisation tranche as
liquid and its actual liquidity exhibited in the
marketplace--this is especially likely for sub-senior
tranches, in particular those issued against non-
diversified portfolios.
(+) The differential regulatory treatment could
underscore the enhanced safety of senior
tranches. Especially if a standardised senior
tranche emerges in the market, it may more
naturally become a benchmark.
35
is a crucial aspect for investors' trust, which is itself particularly important in determining
the chances of success of a completely novel product. Irrespective of the decision taken
on the options described in this section, four general principles must apply and contribute
to the proper implementation of the product legislation.
(a) Ensuring investors' due diligence (investors' responsibility): The compliance
mechanism is not intended to provide an opinion on the level of risk embedded in the
securitisation, nor any guarantees of payouts. The scope of the compliance
assessment should be strictly limited to criteria establishing the 'foundation approach',
namely applying to the structure of the instrument. Investors should continue
performing careful due diligence of any securitisation of sovereign bonds before
investing.
(b) Responsibility to comply is first on originators. Originators (or arrangers) of SBBS
instruments should bear primary responsibility toward ensuring that their product
fulfils the criteria. They will have to attest that the product is meeting all SBBS
criteria. The onus would remain on originators as they are in possession of the most
complete information regarding the product and are the best placed to make the
determination on the characteristics of the instruments.43
In addition, if the originator
is found liable for misleading or false attestation, sanctions on originators would be
much more effective than sanctions on the securitisation vehicle itself.
(c) Sanctions should be in place for non-compliance. There is a need for appropriate
sanctioning measures for participants in the SBBS market to set the right incentives.
For originators, the measures would refer to normal supervisory sanctioning powers.
Sanctions should be both proportionate and dissuasive to prevent investors being
misled and could range from pecuniary fines to a prohibition against further issuances
for a pre-determined period of time. There is also a need to consider the implications
on investors (e.g. what happens if a securitisation is re-qualified as non-qualifying for
the new regulatory treatment). Investors would, for example, no longer benefit from
incentives attached to the 'SBBS category'. In this case, a transitional period could be
foreseen for investors, e.g. to prevent fire-sales. Specific sanctions should also be
applied to any independent third parties involved in the process.
(d) Appropriate public oversight. In the course of their regular assessments of
prudential requirements (e.g. onsite/off-site examination of solvency requirements),
supervisors will verify compliance with the eligibility criteria. This monitoring is
important to ensure the accuracy of prudential ratios, since these new products would
benefit from a specific prudential treatment. Specific monitoring arrangements should
also be defined for originators of SBBS instruments—especially if they are not
already under supervision, for example by virtue of not being banking entities—and
for potential third parties.
6.4.1. Option 3.1: A compliance mechanism based on self-attestation
Under this option, the responsibility for determining compliance with SBBS criteria
would lie with originator firms, which would be legally liable for attesting that all criteria
43
This information advantage is however very limited in the case of either SBBS or the basket, since the
underlying assets—i.e., euro-area government bonds—are well known to all investors, and they are routinely
traded (so that a relevant price signal is in nearly all circumstances available).
36
were met. They would be required to disclose this attestation in the offer documents after
an appropriate assessment of each of the criteria. Ex-post oversight would be carried out
as in normal supervisory activities. The eligibility of an SBBS securitisation for the
envisaged prudential treatment would therefore still be subject to supervisory checks.
(a) Effectiveness
The attestation would establish legal liabilities for originators, which would create a
safeguard for investors. This approach would not fully eliminate investors' concerns
about conflicts of interests by originators that may affect the objectivity of their
attestation. Therefore misleading self-attestation is the main risk of this approach. Yet it
needs to be kept in mind that, given the specialness of the underlying assets (i.e., euro-
area government bonds), there is little if any scope for discretion on the part of the
originator in how to assemble the product, especially when the "recipe" is basically given
(as is the case under Options 1.1 and 1.3). The risk can be further lowered by ensuring
that false self-attestation would have serious consequences for the originators if unveiled
for example in the course of an inspection by supervisors.
These supervisory checks, which could be carried out on a risk basis, would provide the
overarching guarantee of the correct functioning of the system
Nevertheless, incentives would remain for investors to carry out due diligence (again,
this is expected to be not too involved, thanks to the nature of assets underlying these
new structures and the (simple) requirements to qualify for the envisaged regulatory
treatment. Needless to say, due diligence on the part of investors is key for a safe and
sustainable market.
This approach does not limit in any way the recourse to validation by third parties of a
deal's SBBS status. If the latter will provide value added to investors and originators,
they will require it and a market will arise. It should be noted that, given the specialness
of the new products, the role of a third-party validator would likely be quite limited,
possibly to merely confirming that the structure does contain the stated sovereign bonds
in the stated quantities (and thus confirm, quite trivially, whether these align or not with
the ECB capital key). Differently from other securitisations, in other words, third-party
validators would not need to offer opinions nor due extensive diligence on the underlying
assets, as these are well-known.
(b) Efficiency and impact for stakeholders
This option would increase originators' liability in case of wrongdoing, while maintaining
investors' due diligence incentives. Since supervisors would only be involved ex-post
when reviewing prudential requirements, it could be argued that this setup would
minimize expectations on the part of investors of "bailout" by public entities if something
goes wrong (compared to a setup where investors buy the new product on the basis of a
certification by a public entity—see option 3.3 in section 6.4.3). In addition, third parties
could anyhow be involved in the compliance mechanism if the markets value such an
involvement and are therefore willing to pay for it. This option will therefore not limit in
any way the development of third party validation schemes. If these will provide value
added to investors, these should require it and issuers should adapt.
37
This approach would have limited novel financial implications for public budgets, since
supervisors would check compliance ex-post in the course of their routine supervisory
activities. Originators would have to support the self-attestation costs, which should
however be quite small (the extent to which these are translated to investors would
depend on the competitiveness of the market). In the absence of an ex-ante public
intervention, this approach would not eliminate regulatory risks for investors as
self-attested SBBS instruments could be re-qualified at a later stage.
6.4.2. Option 3.2: Option 3.1, with the involvement of third-parties
Similar to option 3.1, option 3.2 would rely on self-attestation by originators. It would,
however, be complemented by the mandatory involvement of a third party, for
certification and/or for management purposes. As investors may have concerns with
fraudulent declarations by originators, they might view self-attestation as not sufficient to
build the critical amount of trust for the SBBS market to take off. A control system
relying on independent third parties could thus be established to prevent the issuance of
non-compliant SBBS instruments.
This option could build on EU procedures in place to establish labelling in other areas.44
'Control bodies' could be designated to perform specific checks to assess compliance with
the eligibility criteria. These bodies would in turn respect requirements defining the
nature, frequency and conditions of their controls. A specific oversight or licensing
regime would have to be developed in order to authorise and monitor these independent
bodies.
(a) Effectiveness
Under option 3.2, the self-attestation would be complemented by an independent review
of compliance with the eligibility criteria. This approach would help address any
concerns related to the truthfulness of originators' prospectuses, providing additional
confidence to investors. Appropriate safeguards would be needed to prevent and address
potential conflicts of interests with originators, especially if third parties were to rely on
"issuer-pays" models.
If properly performed, third-party reviews would give additional assurance to investors.
The drawback is that the third-party review may induce lower scrutiny and due diligence
by investors. It should be noted that, in the case of tranched products, to some extent
relieving investors of the need to do due diligence could be considered as part and parcel
of the creation of a "liquid low-risk asset", as arguably one feature of such an asset is that
it can and will be traded with "no need to ask questions". To the extent however that
sub-senior tranches are not standardised, reducing incentives for due diligence by
investors can be suboptimal.
(b) Efficiency and impact for stakeholders
This option would rely on private sector entities to perform independent assessments of
SBBS. Several entities may enter into this market and competition could limit the costs
44
For instance for organic products (i.e. Council Regulation n°834/2007)
38
for issuers. Involving private entities would make the mechanism more flexible and
scalable to market activities. However, it would also imply additional costs, though as
discussed these could be expected to be small since the third-party validator/reviewer
merely needs to confirm that the content of the structure is exactly as advertised in the
prospectus.
This approach would have similarities with other EU policy, in particular the procedures
for EU labelling. Public oversight of the independent entities could also build on the
approach developed for the registration and oversight of credit rating agencies. It is
important to note that this approach may present similar issues and risks causing
'overreliance' on third parties, as has arguably been the case with credit rating agencies.
Originators and investors may favour this option, if they would share part of the
liabilities with third parties. Their increased confidence notwithstanding, investors would
not get full regulatory certainty, as the final prudential determination of compliance
would remain with the supervisors.
6.4.3. Option 3.3: Option 3.1 with ex-ante supervisory checks on each
issuance
Similar to option 3.1, option 3.3 would rely on the self-attestation of originators,
complemented by ex-ante checks by supervisory authorities. This option would offer a
higher degree of credibility due to the specific status of supervisory authorities.
Furthermore, prudential authorities benefit from a wider overview of market practices
and are less likely to be subjected to issues related to information asymmetries.
Moreover, with no ’issuer-pays’ model, no conflicts of interest should arise.
This approval mechanism would be developed for each issuance of the new instrument.
This would ensure that each individual issuance meets the eligibility criteria. Compared
to the previous options it would, however, imply higher compliance costs for securities
regulators, but again should not be too expensive because of the simple nature of the
instrument and its underlying assets. Checking the legal setup, for example in terms of
the correct specification of the waterfall of payments in case of an SBBS proper, may be
more costly. But it is likely that a standard setup would emerge, reducing such
monitoring costs over time.
Alternatively, an 'issuer-based approach' could be developed. This would mainly focus
on processes implemented by originators to ensure compliance with eligibility criteria.
This would result in a kind of license granted by the authorities. The initial licensing or
approval would be comprehensive and detailed, and thus somewhat more resource
intensive, but it would reduce the subsequent compliance costs, as originators would not
be required to renew approval for every new transaction. This setup would thus favour
large originators, which could amortise the licensing costs over larger volumes.
(a) Effectiveness
Instead of relying on independent third parties, supervisors would directly assess the
compliance with eligibility requirements. This approach would be the most powerful to
ensure investors' confidence. This option would contribute to a sustainable development
of these new markets, while reducing the risks of confidence crises and attendant
spillovers, which in the limit could jeopardise financial stability.
39
However, reliance on supervisors would reduce substantially investors' incentives to
perform thorough due diligence. It could also generate expectations of "bailouts", should
the products experience difficulties. Also, this would reduce the responsibility of issuers,
as supervisory approval would be necessary.
(b) Efficiency and impact for stakeholders
This option would be the most efficient in terms of ensuring the credibility of the new
products. However, it would require greater public resources as supervisory authorities
would have to take on new tasks. These costs would, of course, be minimized if the
"SBBS proper" model is chosen, whereby detecting non-compliance with the given
"recipe" (i.e., portfolio weights and tranching levels) would be relatively straightforward.
While investors and originators may appreciate the legal certainty associated with a
supervisory review, supervisory authorities may face additional liabilities and concerns
about moral hazard issues.
6.4.4. Impact summary and conclusion
Error! Reference source not found. summarises the relevant considerations.
Table 3: Option 3 (Compliance mechanism)—summary assessment
Option/
Specific
objectives
Option 3.1:
Compliance mechanism
based on self-attestation
by originators
Option 3.2:
Option 3.1 with the
involvement of third-
parties
Option 3.3:
Option 3.1
complemented by ex-
ante supervisory checks
on each issuance
Effectiveness (=) Investor confidence
would depend on
reputation of issuer and
potential sanctions
(++) Reduced "moral
hazard" risks as
incentives for due
diligence remain high
(+) Investor confidence
would be increased as
independent assessment of
eligibility criteria will be
available
(-) Increased "moral
hazard" risks as incentives
to investors' due diligence
are weaker
(++) Strong and positive
effects on investor
confidence
(--) Increased "moral
hazard" risks as investors
might come to expect
public backing for the
product.
Efficiency (+) Limited costs for
public finance and public
authorities resources.
(+) Higher flexibility and
scalability of the process
(-) Additional costs for
originators and need to
introduce public oversight
for 3rd
parties
(-) Public authorities
would need more
resources to take up new
tasks
Impact on
stakeholders
(+) Better alignment of
incentives between
originators and investors
(liability for potential
risks)
(-) Investors would not
benefit from external
support in assessing
compliance with
eligibility criteria.
(+) Would provide
additional confidence to
investors in assessing
compliance with eligibility
criteria
(-) Even with 3rd
parties
involved, final prudential
decisions would remain a
competence for
supervisors
(=) Greater legal certainty
for investors-originators,
but concerns on the
scalability and timeliness
of the mechanism
(-) Potential reputation
risks for public authorities
40
Although the extent of asymmetric information between originators on one side and
investors/supervisors on the other is even less than in the case of the STS securitisation,
Option 3.1, i.e. attestation by originators, comes across also here, like in the case of the
STS securitisations, as the preferred setup to ensure compliance with the eligibility
criteria of the new products. This setup would ensure that originators remain liable for
issuing instruments meeting eligibility criteria and should incentivise investors to
perform appropriate due diligence, while minimizing novel costs on supervisors (as well
as moral hazard concerns). Issuers should face appropriate sanctions if they make wrong
declarations. This approach could be combined with option 3.2, but on a non-mandatory
basis. Originators would still have the possibility to ask for a review by an independent
third party if they consider that this would provide added value.
7. HOW DO THE OPTIONS COMPARE?
The options described in the previous section can be combined to form "models" which
in turn can inform the proposed product legislation.
Figure 5: The decision tree
41
In particular, Figure 5 shows how combining the options considered in terms of scope of
applicability of the legislation (section 6.2) and extent of restored regulatory neutrality
(section 6.3) generates five distinct models, which will be compared in this section. Note
that the arguments underpinning the superiority of the self-attestation model (Option 3.1)
as setup to ensure compliance with the proposed legislation are largely independent of
the options considered in sections 6.2 and 6.3. Therefore Option 3.1 would be used
regardless of the specific model chosen, and it is not discussed further in what follow.
The comparison among the five models with the baseline (no regulatory intervention) is
summarised in Table 4. The first two rows of the Table capture the extent to which each
model advances the achievement of the specific objectives set out for the legislative
intervention, namely securing "regulatory neutrality" for the new product vis-à-vis euro
area sovereign bonds and facilitating their liquidity (de jure and de facto) and scope for
becoming "benchmark-like" instruments. The other rows assess the various models
against other desirable objectives.
Table 4: Assessment
The different models perform differently against the various criteria. In particular,
models 1, 2 and 5 (in which the legislation would apply to products with pre-specified
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as
euro area sovereign
bonds
Only SBBS proper;
Treat only Senior
tranches as euro area
sovereign bonds
All securitisations;
Treat all tranches as
euro area sovereign
bonds
All securitisations;
Treat only Senior
tranches as euro area
sovereign bonds
Proper SBBS basket;
Treat basket as euro
area sovereign bonds
Regulatory Neutrality yes partial yes partial yes
Liquidity/benchmark
quality
yes yes no no partial
Minimizes capital
requirements?
yes for SBBS
no, sub-senior
tranches would still
command high risk
weights for SA banks
yes
no, sub-senior
tranches would still
command high risk
weights for SA banks
yes
Assembling of the
product does not
result in reduction of
HQLA assets
yes no yes no yes
Does not impair
liquidity of national
sovereign bond
markets
Ambiguous (*). Effects
likely to be small if
market size is limited
Ambiguous (*). Effects
likely to be small if
market size is limited
Effects (if any) likely
to be small.
Effects (if any) likely
to be small.
Ambiguous (*). Effects
likely to be small if
market size is limited
Helps expand amount
of low-risk assets
yes, senior SBBS is
low-risk
yes, senior SBBS is
low-risk
uncertain uncertain no
Facilitates banks'
diversification
yes yes
uncertain, it depends
on what product is
developed
uncertain, it depends
on what product is
developed
yes
Facilitates cross-
border financial
integration
yes especially thanks
to the standardization
yes especially thanks
to the standardization
yes yes yes
Facilitates bank de-
risking
yes
yes, and more than
Model 1, since there
would be a built-in
incentive to offload
junior tranches
uncertain, it depends
on what product is
developed
uncertain, it depends
on what product is
developed. But more
than Model 3, since
there would be a built-
in incentive to offload
junior tranches
uncertain, as it
depends on the
product. Less than
Model 2, since the
asset would be
diversified, but
without the
protection of the
junior tranche
Facilitates smooth
absorption of
asymmetric capital
flows
yes yes
uncertain,
it depends on what
product is developed
uncertain,
it depends on what
product is developed
yes
Effectiveness
Other positive
effects
42
structures) would fare better than models 3 and 4 (in which the proposed product
legislation would apply to any and all securitisations of euro-area sovereign bonds) in
developing a standardised product, which – as also underlined by stakeholders in the
ESRB public consultation (see Annex 2, section 1) and industry workshop (see Annex 2,
section 2) – is key for the liquidity and attractiveness of the new product.
Models 1 and 2, allow the creation of a new euro-denominated, euro area representative
low-risk synthetic asset (the senior tranche), which could over time compete in the
international financial markets with such benchmarks as bonds from the US or Japan
(Models 3 and 4, which lack standardisation, would not).
Model 5, despite featuring standardisation, does not quite achieve that, because it does
not feature tranching (and thus added "protection" to at least the senior tranche). Indeed,
Model 5 could over time even result in an aggregate reduction of AAA-rated assets (see
Annex 4.4). It might also not deliver on de-risking banks' bond portfolios as assets based
on this basket would be riskier than the current portfolios of most banks, thus banks
would have no incentive to swap into this asset. On the other hand however, it offers the
very positive feature of avoiding the complexities associated with securitisations45
(which Models 3 and 4 would not).
So, the choice between Models 1 and 2, on one hand, and Model 3 on the other, comes
down to the relative importance attached to creating a synthetic low-risk asset versus
keeping things simple.
The choice between Models 1 and 2 comes down to a trade-off between maximizing the
"enabling" effect of the proposed regulation (Model 1) versus maximizing its financial
stability benefits (Model 2).
By providing the most favourable regulatory treatment to all tranches, thus for example
ensuring that the development of SBBS markets does not adversely affect banks' access
to high-quality liquid assets, Model 1 is by definition more "enabling" than Model 2.46
Model 2, however, could give greater benefits in terms of overall risk reduction if it led
to a transfer of riskier sovereign exposures from banks to other investors which are better
equipped to handle them and whose financial difficulties would not be expected to put
any direct pressure on public finances of individual Member States.47
Of course, a
necessary condition for this "good equilibrium" to emerge would be that SBBS would
prove economically viable even in the presence of remaining regulatory hindrances of
various types on sub-senior tranches.
45
E.g., properly enforcing the waterfall of payments in the case some underlying bonds experience debt service
difficulties.
46
Recall that, for senior tranches to be "produced", issuers/arrangers have to be confident that sufficient demand
also comes forth for sub-senior tranches.
47
It may be worthwhile noting that setting out incentives whereby banks would not want to hold sub-senior
SBBS tranches (as would be the case in Model 2) does not mean that banks' total exposure to EU sovereign
risk must necessarily decline, as banks could decide to switch their entire current holdings of EU sovereign
bonds into senior SBBS. Again, as discussed in Section 6.3.2, the net effects on the funding costs of euro-
area sovereigns would depend on several factors, including the elasticity of demand for sub-senior SBSB by
investors not subject to CRR requirements (e.g., hedge funds).
43
8. PREFERRED OPTION
8.1. Preferred model
Our analysis shows that, given the importance of standardisation for the development of
a benchmark-type asset, Models 3 and 4 are likely to be inferior.
As far as the remaining models are concerned, however, each has different strengths in
addressing different issues. No clear conclusions thus emerge from the analysis as to a
single best model (understood as a single collection of best options) in terms of both
effectiveness and efficiency. Political considerations will be required, therefore, to
prioritise the choices, based on the impacts and trade-offs presented in the preceding
sections.
Regarding the regulatory treatment of the different tranches of the product, Model 1
would restore full regulatory neutrality, which would maximize the ’enabling’ effect of
the legislation. Model 2 would be less ’enabling’ than model 1 and would (by design)
level the regulatory playing field only up to a point, i.e. only for the senior tranches. It
might, however, lead to greater de-risking by banks, and thus greater financial stability
benefits, if—despite the higher charges on sub-senior tranches—SBBS nevertheless
proved viable. Model 5 would be enabling to the extent only that it is de facto the
regulatory treatment that is currently hindering the instrument's natural emergence.
Regarding the choice of the compliance mechanism, as with the STS securitisation, a
model based on attestation by originators, possibly complemented by third party
certification on a voluntary basis (option 3.1 in section 6.4), is the preferred option as it
would ensure that originators remain liable for issuing instruments meeting eligibility
criteria and incentivise investors to perform appropriate due diligence, while minimizing
novel costs on supervisors (as well as moral hazard concerns).
8.2. REFIT (simplification and improved efficiency)
This initiative introduces new rules for a new financial instrument, namely SBBS. This
initiative simplifies the regulatory treatment of this instrument and should enable the
development of a new market. Simplification concerns several aspects, including the
restrictions on investing in these instruments by some financial institutions.
9. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?
In terms of securing the specific objectives (i.e., eliminate regulatory hindrances and
contribute to the liquidity of the new products, including by granting them "benchmark"
regulatory treatment), if either model 1 or 3 is chosen, all that can be achieved by
legislation is indeed achieved once the proposed legislation is approved and enters into
force (because only a standardised product would then be made eligible, capital
requirements would be effectively eliminated, and the best possible treatment as far as
liquidity coverage requirements would be granted). For model 2, which would involve
some calibration (e.g., for the risk weights of sub-senior tranches for pillar-1 capital
requirement purposes), regular monitoring after sufficient data has become available
(say, in three or five years) would be helpful to ascertain whether the calibration chosen
remains appropriate.
44
In terms of the general objective to enable markets for these new products, (i.e., SBBS or
baskets, depending on the model ultimately chosen) the impact of the legislation will be
assessed by monitoring the extent to which these new products will be actually
assembled and traded, and—in turn—how much they contribute to the benefits measured
by the benchmarks presented in section 6.1.2 (e.g., expanding the amount of low-risk
assets, reducing the "home bias" in banks' sovereign bond portfolios, etc.). Information
on the amount of SBBS assembled and traded is expected to be readily available,
including because of the envisaged notification and registration requirements for each
issuance. As regards the other benchmarks, data on the aggregate amount of
euro-denominated low-risk (e.g., AAA-rated) instruments, or on the ratio between banks'
holdings of bonds issued by their own government relative to their total holdings of
sovereign bonds, or on the relative share of highly-rated sovereign bonds on banks'
balance sheets are also readily available. The extent of their impact on the liquidity of
national sovereign bond markets will also be assessed, using traditional measures of
liquidity (e.g., bid-ask spread, volume traded, etc.). It is proposed that the Commission
produces a report five years after the entry into force of this regulation, and at 5-yer
intervals thereafter.
When interpreting the results of the afore-mentioned monitoring activities, it needs to be
kept in mind, however, that both the development of this new market and the evolution of
most if not all of the above-mentioned benchmarks depend on several other factors which
are independent of, or may be only tenuously linked to, the regulatory framework. This is
likely to make it difficult to disentangle the effects of the proposed legislation per se. In
particular, for example, the supply of new products is also likely to depend on such
factors as the legal costs (i.e., lawyers' fees) of setting up the issuing vehicle, the ease of
procuring bonds of sufficiently uniform terms on either the secondary or primary market,
the costs of servicing the structure, etc. Similarly, the demand of SBBS will depend on
the overall interest rate environment, the risk appetite, and the demand from various
investor types for the different tranches, etc. Market developments may also well be non-
linear, as it is in the nature of the envisaged product that it benefits from returns to scale
from size and network externalities. Thus, for example, if the product appears to attract
sufficient investor interest, it is possible that debt managers may decide to organise
dedicated auctions for the production of SBBS, with standardised bonds of varying
maturities. This would, in turn, reduce production costs and could accelerate the growth
of the market.
45
LIST OF REFERENCES
Altavilla, C., Pagano, M., & Simonelli, S. (2016), "Bank exposures and sovereign stress
transmission", Working Paper 11, European Systemic Risk Board.
Banca d'Italia (2014), "The negative loops between banks and sovereigns", occasional
papers, number 213, by Paolo Angelini, Giuseppe Grande and Fabio Panetta,
http://www.bancaditalia.it/pubblicazioni/qef/2014-0213/QEF_213.pdf.
Basel Committee on Banking Supervision (2017), "The regulatory treatment of sovereign
exposures", Discussion Paper (December 2017), https://www.bis.org/bcbs/publ/d425.htm
Bessler, W., A. Leonhardt and D. Wolf (2016). “Analyzing hedging strategies for fixed
income portfolios: A Bayesian approach for model selection.” International Review of
Financial Analysis, Forthcoming.
Brunnermeier, M.K., L. Garicano, P. Lane, M. Pagano, R. Reis, T. Santos, D. Thesmar, S.
Van Nieuwerburgh, and D. Vayanos (2016a). “The sovereign-bank diabolic loop and
ESBies.” American Economic Review P&P, 106(5): 508-512.
Brunnermeier, M., S. Langfield, M. Pagano, R. Reis, S. Van Nieuwerburgh and D. Vayanos
(2016b), ESBies: Safety in the tranches, No 21, ESRB Working Paper Series, European
Systemic Risk Board, https://www.esrb.europa.eu/pub/pdf/wp/esrbwp21.en.pdf
De Marco and Macchiavelli (2016), "The political origin of home bias: the case of Europe",
Finance and Economics Discussion Series, Federal Reserve Board, 2016-060.
Erce. A (2015), "Bank and sovereign risk feedback loops", Working Paper Series 1, ESM,
https://www.esm.europa.eu/sites/default/files/esmwp1-09-2015.pdf.
European Commission (2017), "Reflection paper on the deepening of the economic and
monetary union", https://ec.europa.eu/commission/publications/reflection-paper-deepening-
economic-and-monetary-union_en.
European Systemic Risk Board High-Level Task Force on Safe Assets (2018a), "Sovereign
bond-backed securities: A feasibility study", Volume I, January 2018,
https://www.esrb.europa.eu/pub/task_force_safe_assets/shared/pdf/esrb.report290118_sbbs_
volume_I_mainfindings.en.pdf.
European Systemic Risk Board High-Level Task Force on Safe Assets (2018b), "Sovereign
bond-backed securities: A feasibility study", Volume II, January 2018,
https://www.esrb.europa.eu/pub/task_force_safe_assets/shared/pdf/esrb.report290118_sbbs_
volume_II_technicalanalysis.en.pdf.
Gao, P., P. Schultz and Z. Song (2017). “Liquidity in a market for unique assets: specified
pool and to-be-announced trading in the mortgage-backed securities market.” Journal of
Finance, 72(3): 1119-1170.
Guembel and Sussman (2009), "Sovereign Debt without Default Penalties", Review of
Economic Studies, 76, 1297–1320.
Horváth, B L, H Huizinga, and V Ioannidou (2015), "Determinants and valuation effects of
the home bias in European banks' sovereign debt portfolios", CEPR Discussion Paper 10661.
Juncker, J.-C. (2017a), "State of the Union Address 2017", 13 September 2017,
SPEECH/17/3165, http://europa.eu/rapid/press-release_SPEECH-17-3165_en.htm
46
Juncker, J.-C. (2017b), "Letter of intent to President Antonio Tajani and to Prime Minister
Jüri Ratas", 13 September 2017, https://ec.europa.eu/commission/sites/beta-
political/files/letter-of-intent-2017_en.pdf
Persaud (2017), speech at the Nex Conference on the Future of European Government
Bonds, Brussels, 7 November 2017: "Local assets are a good hedge against liabilities linked
to the government and local inflation. It is appropriate that risk-takers take risks with which
they are most familiar".
Schlepper, K., Hofer, H., Riordan, R. and Schrimpf, A. (2017), “Scarcity effects of QE: A
transaction-level analysis in the Bund market.” Deutsche Bundesbank Discussion Paper no.
06/2017.
Schneider, M., Lillo, F. and Pelizzon, L. (2016). “How has sovereign bond market liquidity
changed? An illiquidity spillover analysis.” SAFE Working Paper no. 151.
Schönbucher, P. J. (2003). “Credit Derivatives Pricing Models: Models, Pricing and
Implementation.” London: Wiley.
47
ANNEX 1 PROCEDURAL INFORMATION
1. LEAD DG, DeCIDE PLANNING/CWP REFERENCES
Directorate-General for Financial Stability, Financial Services and Capital Markets
Union (DG FISMA).
DECIDE FICHE PLAN/2017/1678
2. ORGANISATION AND TIMING
Adoption expected in May 2018
3. CONSULTATION OF THE RSB
An upstream meeting was held on 20 October 2017.
The draft report will be sent to the Regulatory Scrutiny Board (RSB) on 19 January 2018.
The RSB meeting took place on 14 February 2018.
The RSB delivered a positive opinion with reservations on 16 February 2018.
4. EVIDENCE, SOURCES AND QUALITY
This impact assessment is based primarily on the analysis done by the ESRB HLTF. The
report of the ESRB HLTF was published on 29/01/2018. The European Commission
(DG FISMA and DG ECFIN) contributed intensively to the overall analysis of the HLTF
and its report. The assessment is based on analytical analysis, a public stakeholder
consultation, a stakeholder workshop and bilateral meetings with stakeholders.
In particular these include the following:
 A dedicated industry workshop was held in Paris in November 2016
(https://www.esrb.europa.eu/news/schedule/2016/html/20161209_esrb_industry_
workshop.en.html).
 A public survey/questionnaire was run on the ESRB website at the end of 2016/
early 2017 (https://www.esrb.europa.eu/mppa/surveys/html/ispcsbbs.en.html).
 A workshop to gather the views of the Public Debt Managers (DMOs) was
conducted in Dublin on 20 October 2017.
 Statistics and data from various sources, including ECB, EBA, Eurostat.
 Academic (economic) literature (see List of References of the ESRB HLTF report
volume I and II, as well as of this document).
For a detailed description of the methodological approach, analytical methods, and
limitations of the evidence underpinning this impact assessment, see Annex 4.
48
ANNEX 2 STAKEHOLDER CONSULTATION
As part of its feasibility assessment of SBBS, the HLTF has conducted a public
consultation in late 2016 on the ESRB website, and has sought input and feedback from
the industry and from Public Debt Managers (DMOs), including through two dedicated
workshops, respectively an open one in November 2016 in Paris and a closed-door one in
October 2017 in Dublin. The outcomes of these consultations are presented in this annex.
On this basis, and considering that the proposed initiative, by its very nature, would not
directly affect retail consumers or investors, it has been decided that no further public
consultation is necessary.
1. RESULTS FROM THE ESRB PUBLIC SURVEY ON SOVEREIGN BOND-BACKED
SECURITIES
48
The ESRB HLTF on safe assets ran an industry survey to consult with stakeholders on
various open questions regarding the possible implementation of SBBS. The
questionnaire sought feedback on several key issues that have been identified internally
by the task force, as well as some concerns that have arisen following the bilateral market
intelligence meetings. The survey was published on the ESRB website on
22 December 2016 and closed on 27 January 2017.
The survey received 15 credible responses from four investment banks, three commercial
banks, four asset managers, three funds and one clearing house. The raw data has been
carefully analysed and various useful insights have emerged. Overall the responses were
in line with feedback that task force members have received in bilateral meetings, but
some unexpected responses were also given (such as on the expectations for the senior
bond’s credit rating). A breakdown of answers on key questions and general conclusions
drawn from the survey are shown below.
1.1 Senior SBBS
To what extent do you perceive a shortage of low-risk and highly liquid euro assets?
Respondents seem to agree that there is an issue with the supply of safe assets.
Answer Breakdown:
2 felt that there is Considerable Shortage
8 felt there is Partial shortage
4 do not believe that there is a shortage of safe assets. In particular 1 highlighted that
there is “No shortage in terms of availability - the price is just high, but low-risk and
highly liquid assets can always be purchased”.
1 did not answer
In which asset class would you categorise senior SBBS?
There seems to be a division amongst market participants as to the asset classification of
SBBS. This is not inconsistent with the feedback received in Paris and bilateral meetings,
48
Prepared by staff of the ESRB's Secretariat. The survey itself is introduced at this address:
https://www.esrb.europa.eu/mppa/surveys/html/ispcsbbs.en.html and presented here:
https://epsilon.escb.eu/limesurvey/123521?lang=en
49
as many admitted that they could see arguments for an SBBS being both a bond and a
structured product.
Answer Breakdown:
6 perceive it is a government/supranational bond only
6 perceive it as a structured product only
3 perceive as both a bond and a structured product
One respondent noted that for the Senior SBBS to be classified as a government bond it
would need to meet structural (“fixed rate, bullet nominal”), regulatory (“ECB collateral,
solvency capital for banks and insurance equal to govies”) and market transparency
(“rules of issuance, timing”) requirements.
There are several ways to measure credit risk. How would you score these different
risk measures in terms of their usefulness for evaluating the properties of senior
SBBS?
Very
Useful
Useful Partly
Useful
Not
Useful
No
Answer
Probability of Default 7 4 0 0 3
Expected Loss 7 3 1 0 3
Value at Risk 4 6 2 0 2
Expected Shortfall 3 4 2 0 5
Marginal Expected Shortfall 1 4 1 1 7
CoVar 2 4 1 0 7
If you have chosen “other” in question 3, above, please elaborate on the additional
risk measure to which you referred.
Two respondents indicated that different risk metrics to the one above would be very
useful. Specifically one referred to the relationship of SBBS with the euro swap rate. The
other hinted on the importance of “Stress loss under extreme but plausible market
conditions” and default correlations.
One respondent indicated that “Markets would probably price this on an expected loss
basis (CDO type pricing).”
What spread (in basis points) would you expect in the yield-to-maturity of 10-year
senior SBBS relative to 10-year benchmark German bunds? If possible, specify the
precise expected spread in the free text box.
Answer Breakdown:
1 Between -50bp and 0bp
7 Between 0bp and 50bp
4 Between 50bp and 100bp
2 Did not answer
Which long-term credit rating would you expect to be assigned to senior SBBS?
At the Paris workshop, several participants expressed scepticism that senior SBBS could
achieve a AAA rating. However, most survey respondents felt that senior SBBS would
be rated AAA.
50
Answer Breakdown:
8 AAA
7 AA
Low-risk assets typically appreciate in value during periods of stress. If perceived
sovereign risk were to increase, would you expect the value of senior SBBS to
increase, stay the same, or decrease?
Surprisingly, respondents were split on this question. Analytical work done by experts of
the task force indicates that there is negative correlation between the yields of the
tranches in stress times. Investors would flee from riskier securities and seek haven in
safe assets. Respondents do not unanimously share this finding, however.
Answer Breakdown:
6 Increase
5 Decrease
1 Other: “Decrease if Eurozone crisis”
3 Did not answer
How important is the liquidity of senior SBBS?
Respondents perceive liquidity of the senior bond as Very Important. This is in line with
the feedback perceived in bilaterals and in Paris.
Answer Breakdown:
13 Very Important
2 Did not answer
To ensure adequate liquidity of senior SBBS, which categories of maturities would
need to be issued?
There seems to be a slight preference from respondents for the term structure of SBBS
should cover the most liquid points vs the entire curve.
Answer Breakdown:
6 Issuance at most liquid points of the curve
5 Issuance at all points of the curve (from the very short to the very long end)
4 Did not answer
To ensure adequate liquidity of senior SBBS, to what extent is it important for them
to be highly standardised? Or could there be some degree of flexibility (e.g.
regarding portfolio weights)?
Respondents clearly prefer a high standardisation of SBBS, which reflects the importance
of homogeneity across different SBBS series.
Answer Breakdown:
9 High standardisation – the prospectus should fix portfolio weights with no scope for
deviation
4 Medium standardisation – the prospectus should allow only very limited deviation
(within a small min/max range)
2 Did not answer
51
What is the minimum total notional value of senior SBBS necessary to ensure
adequate liquidity?
Respondents do not seem to agree on an exact figure but consensus is that the notional
should be relatively high. Specifically, most agree that any size below 250bn will not
result in a liquid enough market. A relatively high number of participants did not answer
this question.
Answer Breakdown:
2 More than 1500bn
1 Between 1000-1250bn
2 Between 500-750bn
2 Between 250-500bn
2 Less than 200bn
6 Did not answer
What is the minimum monthly issuance of senior SBBS (in terms of notional value)
necessary to ensure adequate liquidity?
Similar to the previous question, there is no clear answer as to what precise monthly
issuance size can guarantee adequate liquidity. It seem that a target around the
EUR 10 billion mark could suffice. A relatively high number of participants did not
answer this question.
Answer Breakdown:
1 More than EUR 20 billion
2 Between EUR 15 billion and EUR 20 billion
4 Between EUR 10bn and EUR 15 billion
2 Between EUR 5 billion and EUR 10 billion
1 Less that EUR 5 billion
5 Did not answer
Why might your institution hold senior SBBS?
Responses
Asset-Liability Management (of maturity mismatch) 5
Collateral 8
Investment Return 4
Liability-driven Investment 2
Liquid store of value 9
Regulatory requirements 7
Safe store of value 4
Assuming that senior SBBS are designed such that they meet your requirements in
terms of credit and liquidity risk, what percentage of your institution’s current
holdings of central government debt could be replaced by senior SBBS?
Overall it seems that the substitutability should be quite low in absolute values but it is
very consistent with an incremental approach to SBBS market development. Answers to
the survey indicate that institutions would be willing to substitute, on average, around
52
10% of their holdings into SBBS. A high number of participants did not answer this
question.
Answer Breakdown:
1 More than 100%
1 90-100%
1 20-30%
2 10-20%
2 0-10%
8 Did not answer
1.2 Junior SBBS
In which asset class would you categorise junior SBBS?
Here we observe that many respondents have different views on senior vs junior SBBS.
Many indicated that the senior could be classified as a bond think that the junior is only a
structured product. This divergence in perception is likely to have arisen due to the
different risk profiles of the two tranches. More risk averse market participants are
hesitant to see the junior SBBS being treated like a bond (either in regulation or as an
investment opportunity), even though transparency and the look-through approach can be
applied in the same manner as in the senior SBBS.
Answer Breakdown:
3 Bond only
8 Structured product only
2 Both bond and structured product
2 Did not answer
One respondent noted that that junior SBBS could be perceived as a bond as long as
structural, regulatory and market transparency rules are satisfied (see the same question
for senior SBBS above).
There are several ways to measure credit risk. How would you score these different
risk measures in terms of their usefulness for evaluating the properties of junior
SBBS?
Very
Useful
Useful Partly
Useful
Not
Useful
No
Answer
Probability of Default 6 3 0 0 5
Expected Loss 5 4 0 0 5
Value at Risk 4 3 1 0 6
Expected Shortfall 3 3 0 0 8
Marginal Expected Shortfall 2 2 0 1 9
CoVar 2 1 2 0 9
If you have chosen “other” in question 2, above, please provide an explanation.
One respondent indicated that different risk metrics to the ones above would be very
useful: “Stress loss under extreme but plausible market conditions” and default
correlations.
53
Also one respondent indicated that “Markets would probably price this on an expected
loss basis (CDO type pricing).”
Which long-term credit rating would you expect to be assigned to junior SBBS?
7 respondents indicated a non-investment grade rating, while 8 felt the junior could get a
maximum of BBB.
What spread (in basis points) would you expect in the yield-to-maturity of 10-year
junior SBBS relative to 10-year benchmark German bunds? If possible, specify the
precise expected spread in the free text box.
A relatively high number of participants did not answer this question.
Answer Breakdown:
2 More than 300bp
3 Between 200bp and 300bp
3 Between 100bp and 200bp
1 Other: “This would depend on the credit rating achieved by, and the underlying
structure of these products.”
6 Did not answer
Any mispricing between the replicating portfolio of junior and senior SBBS and the
underlying portfolio could in principle be arbitraged away. To what extent would
you expect such arbitrage to take place?
Most respondents seemed to agree that there will be some excess spread. Its size is
debatable but the key insight here is that markets expect excess spread to exist. A
relatively high number of participants did not answer this question.
Answer Breakdown:
4 Negligible arbitrage, excess spread would be significant
5 Some arbitrage, excess spread would be small
1 Significant arbitrage, excess spread would be negligible
5 Did not answer
Would a contractual unbundling option – whereby an investor holding a replicating
portfolio of junior and senior SBBS could swap that portfolio for the underlying
sovereign bonds – facilitate arbitrage?
Respondents seem to agree that unbundling would facilitate arbitrage, albeit to varying
degrees. A relatively high number of participants did not answer this question.
Answer Breakdown:
2 Yes, unbundling option is critical for arbitrage to work
3 Yes, but arbitrage will work even without the unbundling option
2 Somewhat but other frictions would still prevent full arbitrage
1 No, unbundling option would not work, and arbitrage will be limited
7 did not answer
54
Would junior SBBS’ property of embedded leverage enhance their attractiveness in
terms of expected return?
There seems to be an agreement that the embedded leverage property of SBBS could
play a role in attracting higher demand. A high number of participants did not answer this
question.
Answer Breakdown:
2 Certainly yes
4 Probably yes
1 Maybe
8 Did not answer
Would sub-tranching junior SBBS for example in the form of a 15%-thick tranche
of equity SBBS and a 15%-thick tranche of mezzanine SBBS enhance total demand
for the securities?
Answers are consistent with market intelligence meetings, where market contacts showed
more willingness to invest in a mezzanine tranche rather than a 30% thick first loss piece.
Answer Breakdown:
2 Certainly Yes
6 Probably Yes
2 Maybe
2 Probably No
3 Did not answer
One of the “Probably no” respondents, provided further clarification for his answer.
Specifically, they believe that a mezzanine tranche could enlarge potential investors at
the detriment of the placing capabilities of the smaller and riskier junior tranche. The
only caveat to that would be to ensure that the structure is eligible for amortizing cost
under IFRS 9. Such eligibility is achieved only if there is a tranche below the bond in
question and the mezzanine bond could achieve it. They see the lack of existence of
amortising cost treatment as a non-starter for many potential buyers.
How important is the liquidity of junior SBBS?
Respondents feel that liquidity of the junior bond is important but not the same extent as
for the senior bond.
Answer Breakdown:
5 Very Important
4 Important
1 Neutral
1 Not Important
4 Did not answer
55
To ensure adequate liquidity of junior SBBS, to what extent is it important for them
to be highly standardized in a master prospectus? Or could there be some degree of
flexibility (e.g. regarding portfolio weights)?
Similar to the senior bond, there is a lot of merit in having a high degree of homogeneity
among different SBBS series. A relatively high number of participants did not answer
this question.
Answer Breakdown:
7 High standardization - the prospectus should fix portfolio weights with no scope for
deviation
2 Medium standardization - the prospectus should allow only very limited deviation
(within a small min/max range)
6 Did not answer
Why might your institution hold junior SBBS?
Responses
Asset-Liability Management
(of maturity mismatch)
0
Collateral 2 (provided it is accepted by the ECB)
Investment Return 6
Liability-driven Investment 0
Liquid store of value 1
Regulatory requirements 1
Safe store of value 1
Other reasons: Market making and hedging.
Note that MMFs and CCPs indicated that the junior bond would not be eligible for them
to hold.
Assuming that junior SBBS are designed such that they meet your requirements in
terms of credit and liquidity risk, what percentage of your institution’s current
holdings of central government debt could be replaced by junior SBBS?
Respondents mentioned very low degree of substitutability (expected given the different
nature and perception of junior SBBS relative to central government bonds). A high
number of participants did not answer this question.
Answer Breakdown:
1 10-20%
2 0-10%
2 0%
10 did not answer
What changes to the design of junior SBBS would make them more attractive?
Some participants feel that the junior SBBS does not offer enough to motivate outright
investment. The feedback received from answers to the open question was that there
must be additional buffers to protect from the high risk exposure. Some proposals are:
 “A third tranche”
56
 “Since the junior would resemble Greece (and get similar characteristics) a 5%
equity tranche placed at the ESM (with partial corresponding reduction of the Greece
program) should be introduced.”
 “Public issuance and guarantee”
 “Overcollateralization”
 “Ensure bullet nominal structure by
o an exact matching of capital redemption for bond constituents and SBBS
Notes
o a similar timing for the issuance of the SBBS and the bond constituents
 Also a Fixed rate bond requires a good certainty of coupon payments. If the bonds
are paying different coupons at different payment dates, best would be to have a
small coupon to ensure good coupon coverage and certainty, with a mechanism to
deal with excess spread, and some adjustment of the issue price to adjust the junior
SBBS yield.”
1.3 Regulation
What areas of regulation currently disincentivise the development of SBBS?
Explain your answer in the free text field.
Yes Comments
Capital Regulation for banks 5 “0% risk weight necessary”
“Large Exposure Limits, Leverage Ratio, Capital
Requirements”
“they are a structured product”
Liquidity Regulation for banks 5 “HQLA eligibility is key for banks”
“LCR”
“Would need 100% liquidity against them”
“SBBS should be LCR eligible”
Insurance regulation 2 “Solvency 2“
Investment fund regulation 1
Pension fund regulation 1
Capital bank collateral
eligibility
3 “Eligibility as collateral by the ECB is key for banks”
“SBBS should be an eligible asset with a haircut
corresponding to its reduced risk”
Other 3 “all regulation types should adjust to these instruments for
acceptance as collateral or 'safe assets’”
“Index rules and guidelines”
“individual sovereign risks can be accessed through present
markets. little value in bundling risks without sharing them.”
Other Comments:
 “We do not support a change in the current banking regulation for sovereign
exposures. Nevertheless, we consider that the success of Senior SBBS would
somehow be linked to this regulatory change in the underlying assets.”
 “Solvency capital requirements for banks and insurance holding the SBBS should be
similar to those of govies: no capital charge, no securitisation treatment, no
concentration risk.”
57
In your opinion, in the regulatory framework, should SBBS be treated according to:
This result confirms the work of Workstream B of the task force, which is operating
according to the look-through approach. It is also in accordance with the feedback
received in meetings, where participants felt that it would be unfair to SBBS if the look-
through approach was not applied. Answers to the question are strongly in favour of the
look-through approach:
Answer Breakdown:
10 Look-through approach (two emphasized that it should get 0% rw even with a
possible introduction of RTSE)
3 Current regulation on securitised products
2 did not answer
How should voting rights be allocated?
Respondents concluded that voting rights should be allocated according to investors’
holdings. A high number of participants did not answer this question.
Answer Breakdown:
3 Voting rights should be transferred to investors in proportion to their holdings of junior
and senior SBBS
1 Voting rights should be transferred to investors in proportion to their holdings of senior
SBBS
1 Voting rights should be concentrated in the special vehicle
10 did not answer
1 respondent commented that “a trustee should handle the voting rights and represent the
Noteholders.”
What other considerations should inform the design of a regulatory framework for
SBBS?
Answers:
 “EMIR regulation change to allow recognition of full portfolio margining benefits on
SBBS.”
 “A guaranteed repo market or liquidity provider available to exchange SBBS for
cash to post as collateral for variation margin under centrally cleared swaps would be
highly important to us.”
 “If they are anything other than pari-passu with governments from a regulatory
perspective the project will not work. Likely there will have to be a relative
advantage to hold them, to encourage the market initially.”
 “The success of ESBies is conditional to its regulatory treatment in banking,
insurance and pension funds regulation. For ESBies, an special treatment should be
granted in the following areas:
o Credit risk: ESBies should not follow the current regulation for securitized
products. Instead, they should receive a 0% risk weight that reflects their
condition as a risk-free asset.
o Liquidity risk: ESBies need to be recognized as a High Level Liquid Asset, so
that they are eligible to comply with the Liquidity Coverage Ratio.
58
o Market risk: In line with credit and liquidity risk, ESBies should also keep the
preferential treatment that now is granted for national sovereign debt.
o Moreover, and to reflect the own nature of ESBies as a diversified asset, they
should be exempted from the large exposure limit.
o Finally, it is also necessary that they are recognized by the ECB as collateral for
monetary policy operations and also by Central Counterparties in market
operations.
It is necessary to consider that the previous regulatory adjustment would need a
greater one, which is the change of the current regulatory treatment of the
underlying assets, that is to say national sovereign exposures. This potential
change would come with great challenges itself and should be designed and
implemented globally, to avoid creating an un-levelled playing field across
jurisdictions.”
1.4 Economics of SBBS issuance
What are the reasons for the current non-existence of sovereign bond-backed
securities?
Both the task force and feedback from the market intelligence meetings stressed that
regulation has been the main impediment. Even though respondents seem to agree with
that, it is interesting to note that they have also cited various other reasons that have not
been considered so far.
Answer Breakdown:
1 The regulation of both sovereign bonds and securitised products
6 The regulation of securitised products
1 The regulation of sovereign bonds
5 Did not answer
5 Other citations:
 Structuring costs
 Warehousing and execution risks
 High degree of complexity
 2 people felt that the sum of its parts has little to offer compared to the individual
components
 1 indicated that “Until now there was not a perceived market shortage of low-risk
and highly liquid assets, so there was no need of SBBS under the current regulatory
framework.”
What would be the most significant operational fixed and variable costs related to
SBBS issuance?
Yes
Special servicer fees 2
Trading costs 2
Credit rating fees 2
Legal costs 2
Administrative costs 2
Costs related to funding the warehouse 2
59
Other comments:
 capital cost / balance sheet use (ROE)
 regulatory burden of holding
 similar to that of ETF(those above + observability)
It is interesting to note that one respondent believes that “Issuance costs (rating, servicer,
administrative, legal costs) are probably minimal given the size expected”.
Would it be most practicable for assembly of the underlying portfolio to take place
via purchases of central government bonds on the primary markets, purchases on
the secondary markets, or by using existing portfolios?
We observe a very interesting conclusion here. Respondents did not feel that the primary
market is a necessary condition for successful issuance. This is contrary to the suggestion
in the Industry Seminar that DMO coordination would be vital (or the best solution
operationally) for the success of the issuance process.
Answer Breakdown:
7 New purchases from the primary market
3 New purchases from the secondary market
3 Use existing portfolios
3 cannot know
2 did not answer
One respondent noted that the secondary market could be used to recycle the bonds the
Eurosystem already holds.
Given the current characteristics of primary and secondary government bond
markets, would it be feasible to assemble the underlying portfolio and place all of
the corresponding senior and junior SBBS within one week, using all available
technical devices (e.g. advanced book-building)?
Of those that answered most feel that it would be possible. This implies may not be a big
impediment for an issuer to overcome. A relatively high number of participants did not
answer this question.
Answer Breakdown:
1 Yes
3 Probably Yes
2 Probably not
3 Cannot Know
6 did not answer
It is worth noting that none of those who answered “Probably Not” feel that warehousing
is a significant cost. Of the 2 people who answered “Cannot Know”, 1 thinks that such
cost would be recouped by revenues but the other believes that warehousing is a Very
Significant cost.
To what extent would coordinated DMO issuance in the primary market help to
alleviate this warehousing problem?
Respondents agree that DMO coordination would help in alleviation of the warehousing
problem. A high number of participants did not answer this question.
60
Answer Breakdown:
3 Significant Alleviation
2 Partial Alleviation
1 Not relevant or necessary, as the warehousing problem is anyway minimal
9 did not answer
In view of the likely fixed and variable cost structure of SBBS issuance, how many
different SBBS issuers do you expect that the market could sustain in equilibrium?
Respondents do not feel that there is enough room in the market for many issuers. A high
number of participants did not answer this question.
Answer Breakdown:
2 2-5 issuers
5 1 issuer
8 Did not answer
Could SBBS issuance be a profitable operation? Explain your answer in the free
text field.
Most respondents could not give a definitive answer, but some positive feedback was
received. It is interesting to look at the comments provided in the free text field, as 4
respondents feel that SBBS issuance would be a profitable operation provided that
certain preconditions are met.
Answer Breakdown:
2 Yes (“The consolidated yield of SBBS could in the end become more attractive than
the yield combination of the underlying components, provided the product structuring is
made in a way to drive the market to consider those products as standalone credits rather
than structured products (hence 1 single public issuing entity, high standardization, large
volumes by issue (benchmark+taps), dedicated DMO issues to avoid duration mismatch
costs, warehousing costs, complexity, and capacity to build exact same portfolio for
arbitrages.”)
2 Probably Yes (“trading spreads and short term funding profits of unsold bonds”)
6 Cannot Know
5 Did not answer
Who should arrange and service the special vehicle?
Respondents are clearly in favour of a public entity issuing SBBS. This result is very
much in line with feedback in other fora, where investors have stated that they would
prefer some form of public guarantee. Even if the SBBS are in the balance sheet of a
privately owned institution, any involvement of a public entity would provide assurance.
Answer Breakdown:
9 Public Sector entity
1 Public-private entity
5 Did not answer
61
Insofar as the special vehicle is arrange by private-sector entities, would these
private-sector entities necessarily be primary dealers on sovereign debt markets, or
could other types of entities do the job?
Respondents seem to agree that primary dealers should be arranging the SBBS issuing
entity. A high number of participants did not answer this question.
Answer Breakdown:
5 Yes - primary dealers have a natural advantage in arranging SBBS vehicles.
2 No - SBBS vehicles could be arrange by other financial institutions as well as (or
instead of) primary dealers
8 Did not answer
Would your institution consider becoming an SBBS issuer?
Most of the institutions that answered the survey do not have any experience as primary
dealers so it is unlikely that they would ever engage in SBBS issuance. Those institutions
that would consider issuing would do so only if there were considerable regulatory
sponsorship and enough demand. One respondent stated that their institution would only
consider being an arranger and not an issuer.
Answer Breakdown:
1 Yes
7 No
3 Under Certain conditions
4 Did not answer
One respondent indicated that they would consider being market makers of SBBS.
What changes in the regulatory or market environment would make SBBS issuance
more attractive?
Most of the responses hinted to the importance of changing the regulatory regime.
Specific comments can be seen below:
 “Promote them above ordinary derivatives through regulation.”
 “Lower regulatory capital cost.”
 “Pari - passu or better ranking vs euro area government bonds”
 “Look through acceptability, not considered as securitisation”
 “As stated before, we consider that the success of Senior SBBS is conditional to their
regulatory treatment (they should receive a beneficial treatment in terms of credit,
market and liquidity risk and in terms of large exposures limits) and to the regulatory
treatment of the underlying assets. Moreover, they should be recognised by the ECB
as collateral for monetary policy operations and also by Central Counterparties for
market operations. Nevertheless, we consider it key that any changes need to be
implemented at one time. Europe cannot afford to be stuck half-way of the
implementation process of such a change.”
 “Change in the design of the risk, effective liquidity in the market for SBBS which
suppose there is a real need for this product among the investors.”
 “Arbitrage free haircuts of SBBS and bond constituents, similar liquidity of SBBS
and constituents”
62
What do you expect to be the likely impact of SBBS on market conditions for
sovereign bonds?
This is an open question and a single conclusion cannot be drawn. There were mixed
responses, with many assuming a negative impact. All the answers are illustrated below.
 “It depends on their popularity and demand. I am sceptical that they will become a
large portion of the market.”
 “Less sovereign bonds direct issuance”
 “Less supply, but also less demand, possibly leading to difficulty establishing a
liquid curve for some issuers.”
 “Negative impact on spreads and liquidity on some of the underlying sovereign
bonds.”
 “In theory if they are successful then government bond liquidity will decline as more
bonds go into SBBS. Market determination of intra-EMU spreads will be challenging
as they will reflect liquidity more than fundamentals.”
 “With the introduction of SBBS as a new asset class the current void in the middle of
the European sovereign debt market spectrum would be filled.”
 “Very limited, if issuance came from publicly held debt”
 “If successful, they would extract attractive reserve assets but may reduce liquidity in
individual country Eurozone bonds.”
 “We think that It is likely that for some countries, the expected sovereign issuances
are higher than their participation in ESBies, leaving a remaining pool of national
debt in national sovereign markets. The implicit reduction of these markets will have
significant negative consequences for sovereign debt not included in the pool for
ESBies. These bonds will face a sharp decrease in its liquidity, increasing liquidity
the premia and negatively affecting the operations in these markets, with increased
transaction costs. A solution needs to be foreseen for this type of situations.”
 “It really depends on the SBBS reaching the level where they are liquid.”
 “The SBBS would contribute to the emergence of an harmonised EU sovereign bond
market, with some mutualisation achieved through structural features rather than
policy making.”
2. SUMMARY OF THE INDUSTRY WORKSHOP
49
On 9 December 2016, the ESRB held an industry workshop on Sovereign Bond-Backed
Securities (SBBS), hosted by the Banque de France. The purpose of the workshop was
to discuss the feasibility of creating a market for SBBS. Discussions were held under
Chatham House rules. This summary of proceedings is intended to capture in
anonymised form the main insights emerging from each session.
The workshop revealed a broad diversity of views with respect to SBBS’ feasibility.
Overall, participants underlined the necessity for deeper financial integration in Europe.
There was a mix of views as to whether SBBS represent the correct product with which
to achieve deeper integration: some participants expressed fundamental scepticism,
while some others thought that a functioning market for the securities could develop
under certain conditions. The discussions delivered a set of useful insights to inform the
49
This summary was prepared by staff of the ESRB's Secretariat.
63
ongoing work of the ESRB High-Level Task Force, which currently has an open mind
with respect to all aspects of security design.
Several participants in the ESRB industry workshop referred to ESRB Working Paper
no.21 in their remarks. They saw it as a natural reference point, since the working paper
represents the original inspiration behind the creation of ESRB High-Level Task Force
on Safe Assets. However, the task force is not an intellectual prisoner to the working
paper. In several ways, internal thinking in the task force has diverged from the working
paper, following policy discussions. For example, the task force envisages a
considerably smaller size of the SBBS market than is suggested in the working paper.
Insights from the workshop will allow the task force to further develop and enrich the
basic idea of Sovereign Bond-Backed Securities.
Session 1: Motivation
Session participants defined “safe” in terms of low liquidity risk, low volatility risk and
low default risk. “Safety” is therefore a relative concept along these three dimensions.
One participant emphasised the importance of low liquidity risk and low volatility risk in
(the creation of) “safe assets”: while important, low default risk was second-order, in
their view. This implies that an SBBS market should be liquid first and foremost. Two
participants agreed that a liquid SBBS market could be achieved by announcing a
calendar of regular issuance, such that market players would have a reasonable
expectation of large volume in steady-state. In addition, SBBS’ design should be as
simple as possible, such that even relatively unsophisticated investors would be
comfortable trading and holding them. Corresponding repo and futures markets would
also need to be developed to ensure liquidity. One participant emphasised the importance
of the securities’ inclusion in benchmark indices.
One participant pointed to the role of (Senior) SBBS in generating a euro area wide
benchmark risk-free rate curve. At present, many market players use national curves for
discounting. This exacerbates financial fragmentation, particularly in an environment in
which cross-country spreads are high. Moreover, a full term-structure of maturities would
help to boost SBBS’ market liquidity.
One expressed scepticism regarding safe asset scarcity, but also emphasised that
Eurobonds, embedding joint liability among nation-states, would be preferable to SBBS.
In their view, “synthetic Eurobonds” (i.e. SBBS) without joint liability may pose a
problem for certain investors reluctant to hold structured products. Moreover, the
creation of SBBS may send a (negative) signal to markets regarding the limits of
European ambition. There is also a communication challenge related to the proposed new
treatment of simple and transparent securitizations and its interaction with a policy
announcement pertaining to the creation of an SBBS market. On the other hand, a
successful SBBS market could help to revive the broader European securitization market.
Nevertheless, the issuance of a new securitization product is seen as challenging in view
of these instruments’ history over the financial crisis.
Participants broadly agreed that an SBBS market would need initiation by the public
sector, including via:
64
 DMO coordination: DMOs could coordinate issuance for the fraction of their
calendar that is intended for SBBS.
 Regulatory treatment: A necessary condition for the creation of an SBBS market
would be the application of a “look-through approach” to the regulatory treatment of
SBBS, such that they would be treated consistently with the underlying sovereign
bonds. Without consistency of treatment, would-be investors would (be forced to)
treat SBBS as structured products, both in terms of regulation and with respect to
their investment mandates, thereby shrinking the investor base. For one participant,
a regulatory treatment of sovereign bonds that imposed soft or hard concentration
charges would encourage marginal portfolio shifts in favour of SBBS. This was
deemed preferable to risk-based capital charges.
 Simplicity: SBBS should share the characteristics of straightforward fixed income
securities. A simple structure – with fixed portfolio weights on the asset side, and a
maximum of three tranches on the liability side – would encourage investors to view
SBBS as a bond rather than as a structured product.
 Liquidity: The SBBS market should be liquid, including in the build-up phase, when
volumes are below those in steady-state. Liquidity would be supported by a
transparent timetable of SBBS issues, such that investors would have a reasonable
expectation of adequate volumes.
 Clear restructuring procedures: Investors need clarity regarding the work-out
procedure in the event of a (selective) sovereign default.
Session 2: Sovereign debt markets
Session 2 participants emphasised the importance of DMOs’ objective of minimizing
borrowing costs to the taxpayer. Part of these costs is due to the liquidity premia paid by
DMOs. It is therefore important to minimize liquidity premia by ensuring continued
liquidity in existing sovereign debt markets. The SBBS market should therefore be
designed in a way that does not impair liquidity in underlying sovereign debt markets.
Although one participant emphasized that SBBS would harm price discovery on
sovereign debt markets, most thought that a gradual (rather than rapid) development of an
SBBS market – initially in “experimental” or “proof of concept” fashion – would be the
least disruptive. Gradual development would allow market players and regulators to learn
about the impact on secondary market liquidity and to calibrate the program
accordingly.50
At the same time, Session 2 participants reiterated the main insight of Session 1
regarding the importance of ensuring SBBS market liquidity. This could be compatible
with a slow, experimental approach to market development if investors were to harbour
reasonable expectations regarding the steady-state size of the SBBS market. With a
transparent calendar of regular and moderately sized issuances, several participants
50
In another session, a workshop participant noted that a fraction of the underlying portfolio could be used in
repo transactions. This could generate income for the SPV arranger – thereby encouraging new entrants to
capture such expected profits – and alleviate collateral scarcity in sovereign bond markets. As such, this
proposal could alleviate concerns regarding the impact on secondary market liquidity.
65
expressed confidence that adequate SBBS market liquidity would emerge, aided by the
development of functioning repo and futures markets.
Some participants expressed reluctance to build a regulatory treatment that would be
attractive for SBBS while penalising existing sovereign debt.
Participants thought that the most feasible way to gradually introduce an SBBS market
would be for DMOs to coordinate issuance on the fraction that is intended for SBBS, for
example by pre-agreeing to execute a (private) placement of their bonds with an SBBS-
issuing entity. Moreover, bonds would ideally be homogenous in terms of their
characteristics (e.g. maturity, coupon), thereby ensuring commonality of cash flows to
the SBBS-issuing entity over its lifetime. Most bonds would continue to be sold using the
existing mix of placements, syndications and auctions; the current market microstructure
would therefore persist, thereby limiting the effect of SBBS on secondary market
liquidity, and ensuring DMO autonomy with respect to the timing and characteristics of
the (vast) majority of their issuance calendar.
With regard to market making activities, one participant said that market making for the
senior tranche might be possible, while market making in the junior tranche would be
more difficult. Moreover, the profitability for market makers might be lower in the SBBS
market than on current national sovereign debt markets.
Session 3: Commercial banks
As in earlier sessions, several participants expressed scepticism regarding a regulatory
regime that would impose risk-based capital charges on sovereign debt. Instead,
participants favoured incentives for diversification to alleviate banks’ current home bias.
SBBS could represent such an incentive for diversification, particularly if coupled with
soft charges for concentrated portfolios. At the same time, for some participants such a
home bias is a rational behaviour, aiming at minimising asset-liability mismatches.
In general, participants expected that the yield on Senior SBBS would have a positive
spread with respect to comparable German bunds, particularly in the early stages of the
market when liquidity would be at its thinnest. One participant said that the Senior SBBS
yield would most likely be somewhere between the German bund yield and ESM bond
yield.
Several Session 3 participants emphasised the attractiveness of the broad asset class of
supranational and sub-sovereign debt, which offers moderate pick-up in terms of yield
for the same regulatory treatment as central government bonds. SBBS could tap into this
existing investor base, conditional on regulatory changes that would carve-out SBBS
from the existing treatment of structured products. An analogy is provided by covered
bonds, for which the existence of strong national laws ensures low spreads. On the other
hand, one participant thought that a consistent treatment of SBBS relative to the
underlying would be insufficient to engineer demand for SBBS. Banks in core countries
would still be reluctant to rebalance their portfolios towards Senior SBBS (owing to
worries regarding redenomination risk), whereas banks in vulnerable countries would be
reluctant to forego the high returns expected from holding domestic sovereign debt. In
their view, regulators would need to implement a favourable treatment of SBBS (relative
66
to the underlying), but this would have the undesirable side effect of crowding-out
demand for the remaining float of national debt.
Several participants argued that the proposed calibration for the junior tranche (30%)
would be too high relative to the size of the potential investor market. In this respect,
sub-tranching would reduce the size of the high-yield first-loss piece that would need to
be placed with investors but would add to the complexity of the product.
One participant highlighted a dilemma whereby – on the one hand – SBBS issuance
entails a natural monopoly, but public-sector issuance of SBBS would entail implicit
risk-sharing among nation-states. Overcoming this dilemma would require changes to the
features of SBBS issuance that imply natural monopoly. One such change could be the
coordinated DMO issues suggested in Session 2.
Session 4: Non-bank Investors
Session 4 participants began by highlighting their reasons for holding sovereign bonds.
Several participants pointed to the role of liability-driven investment, which calls for
long-dated, fixed-income assets. For these buy-and-hold investors, liquidity is less
important; instead, what matters is low credit risk combined with non-negative returns.
Participants emphasised that the attractiveness of SBBS is a relative value proposition.
Investment decisions would be based on SBBS’ expected risk/return relative to other
investible assets.
 One participant expressed a preference for Senior (rather than Junior) SBBS,
conditional on regulatory reform that would define SBBS as sovereign bonds rather
than structured products. To be used as a duration instrument, Senior SBBS would
ideally need to be rated AAA, with a moderate pick-up compared with other AAA-
rated assets. Transactions costs for trading SBBS would also need to be low.
 Another participant claimed that risk managers would treat SBBS as a securitization,
regardless of the existence of regulation that may define it otherwise. This could
impede the extent to which Senior SBBS could be used to manage duration risk.
 Another participant claimed that redenomination risk should be taken into account
because it influences ratings and pricing.
 A third participant said that they may hold Junior SBBS in (relatively niche) funds
that permit holdings of structured products. In their view, Senior SBBS would only
be held by sovereign bond funds if they were to comprise part of the benchmark
against which performance is evaluated. In general, holding Senior SBBS in a
sovereign bond fund would be difficult or impossible in the absence of changes to
the mandates of such funds that otherwise prohibit holdings of structured products.
This would require investors to perceive SBBS as a non-securitised product.
 Two participants claimed that the “maths don’t add up” in terms of the likely yield
on Senior and Junior SBBS relative to the underlying. In their view, prospective
holders of Junior SBBS would require a very high return, such that the Senior SBBS
yield would be negative in the current environment.
67
Session 5: Demand for junior SBBS
Session participants agreed that regulatory change would be necessary to ensure the
success of an SBBS market – echoing earlier contributions. One participant noted that –
even with regulatory reform – holders of SBBS would continue to bear “regulatory risk”
(as the future framework could again be changed to penalize SBBS, just as recent
reforms have penalized ABS).
Participants discussed the size of the potential investor base for Junior SBBS. One
participant said that Junior SBBS represents “high octane” sovereign risk, and would
therefore compare naturally to emerging market sovereign debt. There is an investor base
for such risk exposure, but it is relatively niche. Another participant said that investors
would evaluate the relative attractiveness (in terms of risk/return) of Junior SBBS
compared with (high-yield) corporate bonds. This suggests finite investor capacity for
high-yield debt instruments. As such, there may be a natural limit on the size of the
SBBS market. The point at which this limit is reached could be identified by a step-by-
step approach to growth in the SBBS market.
Several participants expressed concerns regarding high correlations between the
underlying sovereign bonds’ probabilities of default. The unconditional probability of
sovereigns’ default is lower than the default probability conditional on the default of
(other) sovereigns. Modelling such conditional probabilities is difficult, however, and
subject to considerable parameter uncertainty. Before the crisis, the market had amassed
a rich stock of expertise capable of pricing such securities in the presence of parameter
uncertainty. While this expertise has now atrophied, it could be revived by an active
SBBS market.
One participant noted that collateralized debt obligations require a positive arbitrage
margin in order to generate profits. Some prospective CDOs generate a negative arbitrage
margin, and do not function for that reason. The same challenge applies to SBBS. To
maximize the probability of a positive arbitrage margin, SBBS issuer(s) could engage in
“ratings optimization” with respect to the tranches. This suggests that at least three
tranches would be warranted (namely first-loss, mezzanine and senior). Such investor
catering could be done by the market via “re-securitizations”, conditional on regulatory
reform to accommodate SBBS2
as well as SBBS.
One participant argued that SBBS could increase the probabilities of sovereigns’ defaults
in equilibrium. Default would be less costly insofar as banks rebalance their sovereign
portfolios away from their current home-biased holdings in favour of Senior SBBS. This
changes sovereigns’ cost/benefit calculation, as a default would be less destructive for the
domestic banking sector and therefore for the functioning of the real economy. At the
margin, then, widespread holdings of Senior SBBS in the banking sector could make
sovereign default more likely.
Session 6: Risk measurement
All participants took a generally conservative approach to SBBS’ risk measurement. In
terms of credit risk, this implies an underlying assumption of high correlations during
stress events. In terms of liquidity risk, this implies a working assumption of low
liquidity until proven otherwise.
68
Several participants noted that correlation among underlying sovereign bonds’ default
probabilities is important for measuring SBBS’ risk but difficult to quantify. A
conservative approach would assume high correlations, particularly during crisis
episodes. Very high correlations would imply that the Senior SBBS would struggle to
achieve a top rating with 30% subordination, particularly given that the underlying
portfolio is “lumpy” as it is comprised of just 19 sovereigns (so that discrete default
events have large effects).
One participant noted that the probability of default of the Junior SBBS would be at least
as high as the highest probability of default in the underlying portfolio. Some credit
ratings take expected recovery rates into account, such that Junior SBBS could benefit
from a better rating than implied by its probability of default, but it was noted that
recovery rates are subject to a high degree of uncertainty. Another participant emphasised
the importance of achieving clarity ex ante on the work-out arrangements for Junior
SBBS in the event of a default on the underlying bonds.
3. MAIN TAKEAWAYS OF THE CLOSED-DOOR DMO WORKSHOP
The HLTF organised a closed-door workshop with DMOs on 20 October 2017 in Dublin.
The workshop intended to offer DMOs an opportunity to express their views on the
SBBS proposal and to seek their expertise on specific (technical) issues.
DMOs raised concerns regarding the design and implementation of SBBS and
highlighted that, in their view, SBBS would not be the appropriate tool to break the bank-
sovereign nexus nor to implement a euro area low-risk asset. More specifically, DMO's
concerns related to the impact on national sovereign bond markets (in particular
liquidity), the implications of primary and/or secondary market sovereign bond purchases
by SBBS issuers, and the possible regulatory treatment of SBBS.
On sovereign bond market liquidity: DMOs stressed that liquidity and transparency on
a marketable volume of debt are a prerequisite for a well-functioning market. Thus,
SBBS would need to be issued in a sizeable amount (up to EUR 2 trillion) in order to be
accepted and bought by investors. This, however, could have a negative impact on the
remaining national sovereign debt markets (reducing liquidity, increasing refinancing
costs, in particular for small and medium sized sovereign debt markets).
On primary and secondary market purchases by the SBBS issuer: The HLTF
considered both secondary and primary market purchases (including dedicated issuances)
as ways for SBBS issuers to build their underlying sovereign bond portfolios. DMOs
stated that either option would cause problems for sovereign issuers, as they would
disrupt market functioning. Further, both options would require a risk-taking treasury
function for SBBS issuers, which—in case of a public issuer—could give rise to
mutualisation of risks. Regarding the proposal for dedicated issuances, DMOs stressed
that it would violate their legal obligations not to offer preferential access and would
have a negative impact on the functioning of sovereign debt markets, notably on market
access, debt rollover in each country, and price formation disruptions.
On the regulatory treatment of SBBS: DMOs highlighted that any regulatory
intervention should not include privileges for SBBS compared to the underlying
sovereign bonds, as this would lead to higher funding costs for sovereigns. They
questioned whether, without regulatory privileges SBBS could ever become viable.
69
ANNEX 3 WHO IS AFFECTED AND HOW?
1. PRACTICAL IMPLICATIONS OF THE INITIATIVE
This annex assesses the different impacts of the identified policy options (models) on the
main stakeholders, as well as on the aggregate financial sector. The key stakeholders that
would be affected by the proposed legislation include banks (and other financial
institutions subject to CRR/CRD), other asset managers, the arrangers/issuers of the
product, supervisors, and debt management officers (as proxies for the effect of the
legislation and of SBBS on the national sovereign debt markets).
The impact, both in terms of potential benefits and potential costs, would depend on the
size ultimately achieved by the market. Since the proposed intervention is an enabling
legislation, and considering that the product to be enabled does not currently exist,
whether or not the market for such product will take off or to what extent is difficult to
predict with certainty. Nevertheless some general considerations can be offered to help
gauge the legislation's possible ultimate impacts, and the channels through which these
would come about. The general costs and benefits, irrespective of the specific option or
scenario considered, are summarised in Table 5 and Table 6, respectively. Table 7 and
Table 8 summarise the possible impact more specifically per stakeholder and respectively
for a scenario in which the enabled product reaches only a limited size, and one in which
instead the product reaches a macro-economically significant size (steady state
scenario)51
. Lastly, Table 9 focusses specifically on the compliance costs for
stakeholders.
51
For example, either EUR 500 billion, which the HLTF report currently envisages could be reached within 10
years, or EUR 1,500 billion, which the HLTF considers as the steady state size of the market, taking into
account constraints which are necessary to safeguard market functioning and price formation.
70
Table 5: Overview of the benefits
I. Overview of Benefits (total for all provisions)
Description Amount Comments
Direct benefits
Eliminated
regulatory
surcharges
#NA.
Capital requirements: At present, holding SBBS would be
associated with positive capital requirements. The proposed
legislation would either completely eliminate these (models 1 and
5) or eliminate them for senior tranches (model 2).
Liquidity coverage requirements: banks would be able use these
new products to meet liquidity coverage requirements, which is
not possible under the current regulatory framework.
These benefits would increase with the market size of the new
instrument. Some indicative calculations to gauge the economic
significance of these benefits are provided in Annex 4.
A new product
becomes available
#NA. A new instrument would become available for banks, insurance
companies, pension funds and other investors. Two scenarios
have been analysed. A "limited" scenario, in which SBBS
develop very gradually and reach a limited volume
(EUR 100 billion) and a "steady state" one where SBBS reach a
macroeconomically significant volume (EUR 1,500 billion).
The actual size of the SBBS market will depend on the
instruments' overall attractiveness for market participants.
A more stable
financial system
#NA. A quantitative assessment is difficult, because of the significant
uncertainty on the extent to which the market would develop.
Nevertheless, from a qualitative perspective, the new instrument
could contribute to financial system stability at large as it would
weaken the bank-sovereign loop. Further, as a share of the
outstanding sovereign bonds would be held in SBBS portfolios,
these bonds would not be quickly sold off in times of financial
market stress.
Expand the
investor base for
European
sovereign debt
#NA. A quantitative assessment is difficult, because of the significant
uncertainty on the extent to which the market would develop.
Nevertheless, from a qualitative perspective, benefits could be
large. In particular for smaller Member States whose sovereign
bonds may not be on the radar screen of investors, demand
coming from the SBBS issuer would facilitate Debt Management
Offices debt placements.
Indirect benefits
Indirect benefits
on retail investors,
households or
SMEs
#NA. These sectors do not benefit directly as they are unlikely to be
active in the SBBS market. They might benefit indirectly –
including from enhanced confidence and lower borrowing costs –
to the extent that the above-mentioned benefits in terms of
enhanced financial stability materialise.
71
Table 6: Overview of the costs
II. Overview of costs
Citizens/Consumers Businesses Administrations
One-off Recurrent One-off Recurrent One-off Recurrent
For all
considered
models
Direct
costs
None None None for
SMEs and
other Non-
Financial
Corporations
For issuers of
the new
product, see
Table 9
None for
SMEs and
other Non-
Financial
Corporations
For issuers of
the new
product, see
Table 9
Creation of
a new
legislation
Supervision
of SBBS
(depending
on the
model, these
costs range
between
limited and
moderate)
Indirect
costs
None If the
introduction of
SBBS were to
impact sovereign
bond market
liquidity, this
could lead to
higher financing
costs for Debt
Management
Offices, which
would in the end
be carried by the
tax-payer. The
analysis
conducted by the
HLTF suggests
that any such
costs would be
limited (see also
Annex 4.3)
None None None None
In general terms, the enabled product would entail the following benefits: eliminate
unjustified regulatory surcharges which allows for the development of a market of a new
instrument, lead to a more stable financial system and expand the investor base for
national sovereign bonds (see Table 5). On the contrary, the costs for citizens, businesses
and administrations appear to be limited (see Table 6).
More specifically (see Table 7 and Table 8), as regards banks and other financial
institutions subject to CRR/CRD, under all models the proposed legislation would have a
positive (or, in the limit, neutral) impact in both scenarios. The legislation could unlock
the assembling and use of new financial products, all of which could—to varying
degree—potentially be used by banks to enhance their risk management.52
With the first
two models, which would ensure greater standardisation in these new markets, banks
may have greater incentives to invest, because the new products would have many of the
features of the benchmark government bonds that banks currently invest in, at least from
52
See Annex 4, section 5 for some calculations on the impact of the introduction of SBBS on banks' sovereign
portfolios under both the limited volume scenario and the steady state scenario.
72
a regulatory perspective.53
Model 1 is the most favourable for the banks (under both
scenarios), because besides gaining access to a potentially liquid product, they would be
able to invest in all of its tranches without facing additional capital charges or liquidity
discounts.54
In contrast, with model 2, banks would have an incentive to buy only senior
tranches.55
As regards the issuers/arrangers, under all models the proposed legislation would have a
positive (or, in the limit, neutral) impact in both scenarios. The impact overall crucially
depends on whether the product would be profitable to arrange or not. Again, model 1
seems to be the most favourable for arrangers in both scenarios.
When it comes to the supervisors the impact under the different policy options crucially
depends on the market infrastructure. It is impossible to predict the impact ex ante. While
the impact would be positive if the product enhances stability of the overall financial
system through more diversified banks (most likely under models 1 and 2), some policy
options might increase the costs for supervisors given the non-standardisation and
different regulatory treatment of the tranches (e.g. model 4).
The impact on DMO's depends mainly on the market size of the new product (limited
volume scenario vs steady state scenario; but also models 1/2 vs. models 3/4) and the size
of the national sovereign bond market. Especially Member States with low debt levels
might be affected more markedly. Under the steady state scenario, large amounts of
SBBS would reduce the amounts of sovereign bonds floating on the market. This could,
for some Member States, result in lower trading and lower liquidity. Under the limited
volume scenario (any such negative impact would be limited.56
At the same time, the fact
that national bonds are bound in the SBBS portfolio/basket, contributes to greater support
in time of volatility, as bonds in the SBBBS structures/basket would not be sold off. To
the extent that SBBS would make the overall financial system more resilient, they could
also help lowering sovereign funding costs.
Regarding compliance costs, only the costs associated with the preferred compliance
setup (that is, option 3.1—self attestation) are assessed. Those are based on the following
actions, which need to be undertaken by different stakeholders for the issuance and
distribution of the new product (we consider in what follows only models 1,2 and 3, i.e.
those for which issuers have to assemble a pre-determined portfolio of euro area
sovereign bonds (in line with the ECB key):
Action 1: Debt issuance by DMO
53
For example, in models 1 and 3, all tranches would be made fully eligible for liquidity-related requirements—
even though as new products the extent to which they would be liquid in practice is unknown a priori.
54
Depending on the demand for bank loans, the extent to which any investment into these tranches would be an
addition to a bank's existing sovereign portfolio or rather a reshuffling of the latter may vary. For example, if
demand (and profitability) of bank loans is strong, so that investment in low-risk but also low-yielding assets
such as sovereign bonds is minimized (and possibly strictly dictated by regulatory requirements), it is likely
that banks would switch their existing sovereign portfolios into these new products, if they purchase the latter
at all. In contrast, in a situation where banks have excess liquidity, it is possible that they might decide to add
to their existing sovereign exposures via these new products.
55
The same logic applies to models 3 and 4.
56
See Annex 4, section 3 for an analysis of the impact of SBBS on national sovereign bond markets, in particular
liquidity.
73
Action 2: Structuration of the product by Arranger (purchase of underlying sovereign
bonds, drafting of legal documentation for the transaction (including, where relevant,
the tranching method and the payment waterfall), issuance of self-attestation)
Action 3: Potential certification (non-mandatory) by Third party
Action 4: Distribution of the SBBS by Arranger on the basis of self-attestation and
potential certification by third party
Action 5: Due diligence carried out by Investors to check the product is compliant
Action 6: Supervisory oversight of regulated investors by Supervisors
It is to be noted that those actions are not necessarily taken in a chronological order, since
for instance the pre-marketing and book building of the product can start before the
underlying sovereign bonds are issued. Similarly, distribution arrangements/agreements
can be entered into before the Arranger puts together the relevant portfolio (and issues
the tranches, if relevant).
2. SUMMARY OF COSTS AND BENEFITS
Table 5 and Table 6 summarise the costs and benefits in general terms. Table 7 and
Table 8 sketch out a summary of the costs and benefits of the five models on for different
stakeholders, first for a limited development of the product and second for the steady
state where the product reaches a macroeconomically significant size. Table 9 focusses
on the compliance costs for stakeholders, on the basis of the actions describe above.
74
Table 7: Impact Assessment Analysis, by Stakeholder Type (limited volume scenario)
Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product
achieves only a limited size.
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as euro
area sovereign bonds
Only SBBS proper;
Treat only Senior tranches
as euro area sovereign
bonds
All securitisations;
Treat all tranches as euro
area sovereign bonds
All securitisations;
Treat only Senior tranches
as euro area sovereign
bonds
Proper SBBS basket;
Treat basket as euro area
sovereign bonds
Banks
Positive.
New products become
available, with minimised
regulatory charges.
Positive.
New products become
available, with minimised
regulatory charges. Banks
would face high charges if
they invest in sub-senior
tranches. This may,
however, lead them to de-
risk.
Positive/Neutral.
Access to more products.
But products may not be
attractive if not
liquid/standardised.
Positive/Neutral.
New products become
available, some with
reduced/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Neutral.
Access to a new
standsardised product. But
product may not be
attractive from a risk-return
perspective and assets
based on the basked would
be riskier than the current
portfolios of most banks.
Other
investors
Positive/Neutral.
Some new products become
available, which may have
benchmark-like properties.
Positive/Neutral.
Some new products become
available, which may have
benchmark-like properties.
Positive/Neutral.
New products become
available, with
minimised/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Positive/Neutral.
New products become
available, with
minimised/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Neutral.
Access to a new
standsardised product. But
product may not be
attractive from a risk-return
perspective.
Arrangers
Possibly positive.
A market may develop out
of standardisation, with no
regulatory disincentives,
and it would have to be
profitable for the product to
be viable (though
competition among
potential issuers could bring
any rent down to zero).
Possibly positive.
A market may develop out
of standardisation, with no
regulatory disincentives,
and it would have to be
profitable for the product to
be viable (though
competition among
potential issuers could bring
any rent down to zero).
More challenging than
model 1 because the
potential investor base for
sub-senior tranches is more
restricted.
Neutral.
Little structure means
maximum flexibility. But
market may not develop for
lack of standardisation →
not profitable.
Neutral.
Little structure means
maximum flexibility. But
market may not develop for
lack of standardisation →
not profitable. Moreover
finding buyers for sub-
senior tranche may be more
challenging.
Neutral.
A market may develop out
of standardisation, but it
would have to be profitable
for the product to be viable.
Supervisors
Depends on market
infrastructure, but positive
if financial system is overall
more stable.
Depends on market
infrastructure, but positive
if financial system is overall
more stable.
Depends on market
infrastructure.
Depends on market
infrastructure.
May be more costly to
monitor/enforce than
model 3.
Depends on market
infrastructure.
DMOs
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Product could compete with
some sovereign bonds. But
effects likely to be small if
market is small.
75
Table 8: Impact Assessment Analysis, by Stakeholder Type (steady state scenario)
Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product
reaches a macro-economically significant size.
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as euro
area sovereign bonds
Only SBBS proper;
Treat only Senior tranches
as euro area sovereign
bonds
All securitisations;
Treat all tranches as euro
area sovereign bonds
All securitisations;
Treat only Senior tranches
as euro area sovereign
bonds
Proper SBBS basket;
Treat basket as euro area
sovereign bonds
Banks
Very positive
Additional benchmark-type
products are now available
at no/low regulatory
charges. The senior tranche,
being low risk, can be quite
effective at isolating banks
from idiosynchratic
gyrations in the price of
individual euro area
sovereign bonds.
Very positive
Additional benchmark-type
products are now available
at no/low regulatory
charges. The senior tranche,
being low risk, can be quite
effective at isolating banks
from idiosynchratic
gyrations in the price of
individual euro area
sovereign bonds. Banks
would face charges if they
held sub-senior tranches.
But this may lead them to
de-risk.
Positive/Neutral.
Access to more products.
But products may not be
attractive if not
liquid/standardised.
Positive/Neutral.
New products become
available, some with
reduced/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Neutral.
Access to a new
standsardised product with
no regulatory charges. But
product may not be
attractive from a risk-return
perspective and assets
based on the basked would
be riskier than the current
portfolios of most banks.
Other
investors
Positive.
Additional benchmark-type
products are now available,
offering different risk-
return profiles which may
cater to different clienteles
Positive.
Additional benchmark-type
products are now available,
offering different risk-
return profiles which may
cater to different clienteles
Positive/Neutral.
New products become
available, with
minimized/no regulatory
charges. But products may
not be attractive if not
liquid/standardised
Positive/Neutral.
New products become
available, with
minimized/no regulatory
charges. But products may
not be attractive if not
liquid/standardised
Neutral.
Access to a new
standsardised product. But
product may not be
attractive from a risk-return
perspective.
Arrangers
Positive.
A new market is now
available, evidently
profitable (though
competition among
potential issuers would
bring any rent down to
zero). The new product may
attract demand which is
additional with respect to
the demand of underlying
bonds. Hence the overall
size of the industry (e.g.,
primary dealers) may be
boosted.
Positive.
A new market is now
available, evidently
profitable (though
competition among
potential issuers would
bring any rent down to
zero). The new product may
attract demand which is
additional with respect to
the demand of underlying
bonds. Hence the overall
size of the industry (e.g.,
primary dealers) may be
boosted. More challenging
than model 1 because the
potential investor base for
sub-senior tranches is more
restricted.
Positive if the market
development is all on one
or a few products only,
which then become
attractive/profitable thanks
to standardisation.
Otherwise, neutral.
Positive if the market
development is all on one
or a few products only,
which then become
attractive/profitable thanks
to standardisation.
Otherwise, neutral. Investor
base for large quantities of
sub-senior tranches may be
more challenging than
under model 3.
Neutral.
A market may develop out
of standardisation, but it
would have to be profitable
for the product to be viable.
Supervisors
Positive.
Banks are likely to be more
diversified, which makes
the financial system more
stable. This is likely to
outweigh any costs from ad-
hoc
supervision/certification/lic
ensing duties.
Positive.
Banks are likely to be more
diversified and to have
carved out the most volatile
exposures, which makes the
financial system more
stable. This is likely to
outweigh any costs from ad-
hoc
supervision/certification/lic
ensing duties.
Depends on market
infrastructure and on the
extent to which the new
products are used by
financial sector players, and
banks in particular, to
effectively reduce risks.
Depends on market
infrastructure and on the
extent to which the new
products are used by
financial sector players, and
banks in particular, to
effectively reduce risks.
Monitoring/enforcing costs
are likely to be greater than
in model 3 but so is also the
de-risking potential fior
banks.
Depends on market
infrastructure.
76
Table 8 (continued):
Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product
reaches a macro-economically significant size in the steady state.
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as euro
area sovereign bonds
Only SBBS proper;
Treat only Senior tranches
as euro area sovereign
bonds
All securitisations;
Treat all tranches as euro
area sovereign bonds
All securitisations;
Treat only Senior tranches
as euro area sovereign
bonds
Proper SBBS basket;
Treat basket as euro area
sovereign bonds
DMOs
Unclear.
To the extent that SBBS
render the financial system
more resilient (e.g., weaken
bank-sovereign loop), they
could help lower sovereign
funding costs. Large
amounts of SBBS would
reduce the amounts of
sovereign bonds floating on
the market. In some cases
(e.g., especially for Member
States with relatively low
debt) this could result in
reduced trading/liquidity.
This would need to be
juxtapposed to any benefit
from greater support in
time of volatility, since
bonds in SBBS structures
would not be sold off.
Unclear.
To the extent that SBBS
render the financial system
more resilient (e.g., weaken
bank-sovereign loop), they
could help lower sovereign
funding costs. Big volumes
of SBBS would reduce the
amounts of sovereign bonds
floating on the market. In
some cases (e.g., esp. for
Member States with
relatively low debt) this
could lead to reduced
trading/liquidity. This
would need to be
juxtapposed to any benefit
from greater support in
time of volatility (bonds in
SBBS structures would not
be sold off). The effect of
greater banks' incentives to
offload junior tranches
depends on the elasticity of
demand for senior tranches
by banks and for all tranches
by other investors.
Unclear a priori.
"Successful" products could
compete with some
sovereign bonds. And,
depending on what these
successful products bundle
together, the liquidity on
some sovereign debt
market could be affected.
The extent to which funding
costs are lowered from
reduced "doom loop" risk is
difficult to assess a priori.
Unclear a priori.
"Successful" products could
compete with some
sovereign bonds. And,
depending on what these
successful products bundle
together, the liquidity on
some sovereign debt
market could be affected.
The extent to which funding
costs are lowered from
reduced "doom loop" risk is
difficult to assess a priori.
The effect of greater banks'
incentives to offload junior
tranches would depend on
the elasticity of demand for
senior tranches by banks
and for all tranches by other
investors.
Unclear.
The proper SBBS basket
could compete with some
sovereign bonds. Large
amounts of proper SBBS
baskets would reduce the
amounts of sovereign bonds
floating on the market. In
some cases (e.g., especially
for Member States with
relatively low debt) this
could result in reduced
trading/liquidity. This
would need to be
juxtapposed to any benefit
from greater support in
time of volatility, since
bonds in the SBBS basket
structure would not be sold
off.
77
Table 9: Overview of compliance costs, option 3.1
DMO Arranger Investor Supervisor Third party validators
Action
(1)
No compliance costs
are expected for
DMOs compare to the
baseline scenario
Some costs could
arise if DMOs have to
increase the
coordination of their
issuance activities
(e.g., issue similar
maturities at similar
times). Such
coordination is not
necessary, however,
and would
presumably be
undertaken only if
deemed worthwhile.
- - - -
Action
(2)
- Compliance relies on
arranger, however
the self-attestation
does not entail any
administrative
burden compared to
the structuration of
other products. The
ESRB HLTF
estimates upfront
costs of
EUR 1.15 million
and annual costs of
EUR 3.26 million
for an SBBS
programme of
EUR 6 billion (see
ESRB HLTF report,
section 4.1.2)
- - -
Action
(3)
- - Such costs would
ultimately need to be
borne by investors;
however since the
mechanism is not
mandatory, this would
not in any event
undermine the viability
of the product. In
addition, and as
explained in greater
detail in section 6.4,
these costs are likely to
be small, given the
limited nature of the
certification/review.
- The compliance costs
associated with non-
mandatory third party
certification would
depend on the level of
competition on this
market. These costs
are likely to be small,
given the limited
nature of the
certification/review
(basically, confirming
that the stated
sovereign bonds are
effectively in the
underlying portfolio
and in the stated
quantities).
78
Action
(4)
- No additional cost
compared to the
distribution of other
structured products
- - -
Action
(5)
- - No administrative cost
is required from
investors; regulated
investors will however
need to ensure the
product purchased
complies with
regulatory
requirements; this is
however inherent to
the activities of
regulated investors and
likely to be relatively
inexpensive, given the
pre-determined
structure of the product
and the fact that it
hinges on euro-area
sovereign bonds.
- -
Action
(6)
Supervisors will
perform their controls
as for any other assets
held by regulated
investors. This does
not entail additional
costs compared to the
baseline scenario
The preferred setup for ensuring compliance (option 3.1) does not entail any additional
cost compared to the regular conduct of business. The only potential compliance costs
may arise from the recourse to a voluntary certification by an independent third party, in
which case the costs would be ultimately borne by investors. Those costs remain
hypothetical, and their quantification would depend on a wide range of factors, such as
the market structure for such business. They are likely to be small, given the limited nature of
the certification/review (basically, confirming that the stated sovereign bonds are effectively in
the underlying portfolio and in the stated quantities). The voluntary recourse to such
mechanism ensures that it would not undermine the viability of the SBBS.
79
ANNEX 4 ANALYTICAL METHODS
This annex covers analytical assessments to provide evidence on (1) the extent of
"hindrance" faced by SBBS at present (pre-1/1/2019); (2) the extent of "hindrance" faced
by SBBS at post 1/1/2019; (3) the extent to which SBBS would impact remaining
national debt markets; (4) an estimation of the impact on the volume of AAA assets; and
(5) and estimation of the impact on the composition of banks' sovereign portfolios.
1. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT PRESENT
This annex is based on the assessment undertaken by the ESRB HLTF, presented in
section 5.5 in volume II of the report and focuses on evidence on the extent of
"regulatory hindrance" faced by SBBS under current regulations (pre-1/1/2019).
The analysis compares the impact on banks' and insurance companies' capital
requirements57
if existing sovereign exposures were replaced by senior SBBS under the
current regulatory regime.58
Analysis for banks
It compares two scenarios:
- Scenario 1 – status quo: SBBS do not exist, and banks hold their existing sovereign
bond portfolios. This is the status quo benchmark against which the alternative with
SBBS is measured.
- Scenario 2 – banks replace their entire sovereign bond portfolios by senior SBBS
under current regulatory treatment. Banks’ SBBS holdings are treated according to
current securitisation regulations (Articles 242-270 of the CRR) and receive a risk
weight of 20% for credit risk. The look-through approach would apply for the
concentration risk charge. This means that the share of each sovereign in the SBBS
(multiplied by the total holdings that are exchanged for SBBS) would be set against
the bank’s Tier 1 capital to determine whether and in which concentration bucket the
exposure to that sovereign would fall. In the case of partial substitution, this amount
would have to be added to the remaining sovereign holdings of each sovereign.
The data used comes from the EBA 2015 Transparency Exercise for end-June 2015 and
includes 105 EU banks at the highest level of consolidation. The data includes exposures
to central government, regional government and local authorities. The composition of
SBBS is assumed to include only euro area sovereign bonds. Further, it is assumed that
senior SBBS obtain a rating within credit quality step 1.
As an illustrative exercise, banks are assumed to exchange their entire portfolio of
sovereign holdings for senior SBBS. This exercise thus generates an upper bound
estimate of the additional capital requirements to which SBBS are subject in the current
57
As regards liquidity coverage requirements, banks would be able use SBBS to meet liquidity coverage
requirements, which is not possible under the current regulatory framework. This would thus constitute a
benefit which would increase with the volume of the new instrument.
58
The analysis of the ESRB HLTF is much wider and covers the impact on capital requirements under different
possible RTSE reform options.
80
regulatory framework, as less comprehensive switches would be associated with lower
associated capital requirements.59
The results are presented in Table 10. They clearly
show that the status quo would lead to a higher cost of holding SBBS versus holding the
underlying directly, given SBBS would have a high credit risk weight of 20% for senior
SBBS under current regulation (Scenario 2). This treatment to which they would be
subject under existing regulation reveals a key reason for the non-existence of SBBS.
Table 10: Capital charges for euro area sovereign exposures or senior SBBS under the two
scenarios (assuming 100% substitution)
Regulation of
(the underlying)
sovereign bonds
Scenario 1
(current sovereign bond holdings; no
SBBS)
Scenario 2
(SBBS: current securitisation
regulation, credit RW: 20%)
EUR billion As a % of
CET 1 capital
EUR billion As a % of
CET 1 capital
Status quo 0 0 70.7 5.0
Notes: Total capital needs refer to the capital banks would have to raise to keep their current CET1 capital ratio
constant.
Source: Report of the ESRB HLTF.
Analysis for insurance companies
A similar analysis has been conducted on the implications for insurance companies60
replacing their sovereign holdings with senior SBBS. Table 11 shows estimates of the
absolute and relative increase in the Solvency Capital Requirement (SCR) for euro area
solo insurance companies if they were to reinvest their current holdings of euro-
denominated sovereign bonds into senior SBBS, and if they are assumed to be treated
under current regulatory rules. These figures underline that under the existing regulatory
treatment insurance companies would have no incentive to hold SBBSs compared to
sovereign bonds.
Table 11: Increase in SCR requirements for euro area solo insurance companies
Status quo:
Treatment of
sovereign bonds
Scenario 1a:
Treatment of senior SBBS as
type 2 securitisation
Scenario 1b:
Treatment of senior SBBS as
type 1 securitisation
Increase in SCR
(EUR billions)
0 963 166
Relative increase in
SCR (%)
0 262 45
Notes: Type 1 securitisations are "high quality" securitisations, while all others are covered under type 2
securitisations.
Source: Report of the ESRB HLTF.
59
At the same time, if banks were to switch not just into senior but also sub-senior SBBS tranches, the resulting
capital requirements would actually be correspondingly larger, since sub-senior tranches under the current
regulatory framework would warrant higher risk weights than senior ones.
60
Euro area insurers hold assets of EUR 7.3 trillion. The current allocation of all euro area insurers to Euro
sovereign bonds is EUR 1.500 billion. The average duration is 8.96 years.
81
2. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT POST 1/1/2019
As discussed in the main text, even after the entry into force of Regulation (EU)
2017/2042 on 1/1/2019, banks using standardised approach for the determination of
capital requirements would not be able to apply a full look-through (and thus benefit
from zero risk weights) to sub-senior tranches of SBBS.
To gauge the extent of this hindrance, albeit somewhat indirectly, we have calculated the
proportion of sovereign bonds which at present are assessed under the standardised
approach.
Using the granular data of the EBA 2017 transparency exercise as of 30 June 2017, we
compare for each bank in the EBA sample (133 banks) the share of government and
central bank exposures assessed under the standard method and the IRB method for
prudential purpose. We then calculate the amount of sovereign bonds hold by those
banks which mainly use the standard method.
The exercise shows that:
 98 out of 133 banks mostly use the standard approach and would thus be subject to
stiff capital requirements if they switched their sovereign holdings into the three
tranches.
 Some 37% of all sovereign bonds in the sample are currently held by those banks
which mostly use the standardised approach.
In addition, since the sample of the EBA includes the most complex banks in the EU,
which are also the most likely to use the IRB approach, our results remain conservative
and tend to underestimate the overall use of the standard method by EU banks.
Therefore the hindrance in the status quo would be rather significant. Indeed, assuming
that banks fully switch their current holdings of sovereign bonds for balanced positions
in all the three SBBS tranches (i.e., invest respectively 70% in the senior, 20% in the
mezzanine and 10% in the junior) and assuming that the mezzanine (respectively, junior)
tranche would attract a capital charge of 80% (respectively 1250%), equivalent to a
quality step 4 (respectively, 17 or higher, including not rated) in the table of Article 264
of Regulation (EU) 2017/2401 (rescaled for STS-like securitisations), aggregate risk-
weighted capital would increase by about EUR 1,675 trillion.61
Of course, this is an upper limit, and its value depends on the assumptions made
(including on the risk weights warranted by the sub-senior tranches). A more limited
switch, for example, would be associated with correspondingly lower capital charges:
assuming that the SBBS market reaches EUR 100 billion, as in the limited volume
scenario discussed in section 6.1 of the main text, and that SA banks would buy some
EUR 62 billion of this amount (in line with their current shares of government bonds in
the overall banking book), aggregate risk-weighted assets would increase by some
61
To translate this figure into an estimate of the aggregate increase in capital requirements, an assumption is
necessary on the aggregate (average) capital requirement ratio. For example, a capital requirement ratio of,
say, 8 % would lead to an increase in aggregate capital requirements of EUR 134 billion.
82
EUR 87 billion. For the steady state scenario in which SBBS reach a much larger scale
(i.e., EUR 1,500 billion), the equivalent calculation yields an increase in aggregate risk-
weighted assets to the tune of EUR 1.3 trillion. (SA) Banks could also decide to only
switch into senior tranches (provided some other investors purchase the sub-senior
tranches), in which case they would face no additional capital requirements.
Even these large amounts are much reduced relative to what would prevail before the
coming into force of Regulation (EU) 2017/2042 on 1/1/2019. The corresponding
calculation for a full switch (respectively, a switch of EUR100 billion) would yield
additional risk-weighted assets of EUR 2,985 trillion (respectively, EUR155 billion).
This larger amount reflects: (i) the fact that, in the status quo and before 1/1/2019, also
IRB banks would face capital charges on their holdings of tranches; and (ii) that also the
senior tranche would face a positive risk weight (assumed at 20% in this calculation).
3. PRESENTATION OF THE ANALYSIS BY THE ESRB LIQUIDITY WORKING GROUP ON
THE EFFECTS OF SBBS ON NATIONAL SOVEREIGN BOND MARKET LIQUIDITY
This section of annex 4 presents the assessment undertaken by the ESRB HLTF, shown
in section 4.4 in volume II of the report on the possible impact of SBBS on sovereign
bond market liquidity.
Concerns were raised regarding the impact of SBBS on sovereign bond market liquidity.
Given that one fraction of currently outstanding central government debt securities would
be "frozen" into SBBS portfolios they would be unavailable for trading.62
The analysis in
the ESRB report derives the implications of SBBS from the liquidity impact of the
Eurosystem's Public Sector Purchase Programme (PSPP).
On the other hand, SBBS would represent new securities with liquidity of their own. In
principle, SBBS could have properties that are comparable to current sovereign bonds,
including high liquidity and collateral eligibility. With a mature SBBS market, such
properties could have positive spillover effects with respect to national sovereign debt
markets. In this section these channels are referred to as the 'spillover effect' of SBBS.
At the same time, SBBS may also help to relieve scarcity of low-risk assets, which is
perceived by some market participants. German sovereign bonds in particular appear
scarce relative to demand, given the role of those bonds in acting as a benchmark asset
for the entire euro area. However, with a higher supply of low-risk assets (senior SBBS),
the excess demand for German sovereign bonds may be smaller. Using SBBS for repo
markets instead of sovereign bonds would contribute towards smooth market
functioning: for every 26 units of German bonds retained by SBBS issuers, there would
be 70 units of senior SBBS.
In the presence of both freezing effects and spillover effects, the net effect of SBBS on
the market liquidity of national sovereign markets is prima facie ambiguous. The
liquidity of SBBS and sovereign bond markets therefore depends on their relative size
62
This could be mitigated by allowing SBBS issuers to lend out the securities in reverse repos, as it is currently
done under the Eurosystem's implementation of its Public Sector Purchase Programme (PSPP). This would
however be at odds with the presumption that issuers would be mere pass-through vehicles.
83
and the corresponding strength of the offsetting freezing and spillover effects. If spillover
effects dominate, both SBBS and sovereign bond markets could be liquid. On the other
hand, if freezing effects dominate, there would be a trade-off between the liquidity of
SBBS and that of sovereign bonds. Also, there is a clear trade-off as the extent to which
SBBS may affect national sovereign debt markets depends on SBBS market size: a large
SBBS market implies adequate liquidity of the asset, but potentially at the expense of
national sovereign debt market liquidity. On the contrary, a small SBBS market would
have limited knock-on effects to national sovereign debt markets, but may consequently
itself be illiquid.
To shed more light on the expected net effect of SBBS on market liquidity, the rest of
this section examines the freezing and spillover effects in turn.
Liquidity impact
The PSPP63
programme is analogous to SBBS insofar as sovereign bonds are removed
from the secondary market but may be available for securities lending. It should however
be noted, that there are two key caveats to the conceptual analogy between PSPP and
SBBS: First, the analysis only holds if an SBBS market – and in particular a large SBBS
market – develops only after an unwinding of PSPP, as both measures together could
have an impact on liquidity of sovereign bond markets given their "freezing effect".
Second, the analogy between the two instruments is imperfect insofar as SBBS and PSPP
entail some important differences. In particular: (1) In parallel to the PSPP, the
Eurosystem implements a securities lending facility to support secondary market
liquidity by alleviating bond scarcity. (2) The PSPP is implemented in a market-neutral
manner, including with respect to maturities (eligible maturities range from 1-30 years).
However, in the early phase of the SBBS market, SBBS issuers might focus on certain
points of the curve – most likely 5- and 10-year debt securities – in order to build liquid
benchmarks to aid price discovery and facilitate the development of a futures market
referenced to SBBS. (3) While SBBS issuers could buy the SBBS cover pool on both the
secondary and the primary market, purchases under the PSPP take place exclusively in
secondary markets. (4) Purchases under the PSPP take place in a continuous manner to
avoid excessive market disruption, while purchases of the SBBS cover pool would most
likely take place in lumpy batches, corresponding to discrete SBBS issuance dates.
(5) An SBBS program would differ from the PSPP insofar as the former constitutes a
partial replacement of long-term bonds with different long-term bonds, while the PSPP is
essentially a partial replacement of long-term bonds with broad money. This implies that
SBBS could be a source of liquidity and hedging opportunities that would help dealers to
provide market liquidity elsewhere.
Nevertheless, the Eurosystem's PSPP represents a significant “stress test” of the likely
impact of SBBS on sovereign bond markets, since aggregate PSPP holdings (as of
63
The Eurosystem’s public sector purchase programme (PSPP) was implemented from 2015. It entails purchases
by the ECB and euro area national central banks of government debt securities and other eligible public
sector securities from the euro area. Purchased securities are effectively “frozen” on the collective balance
sheet of the Eurosystem, and are only available for use in securities financing transactions under the
conditions of the securities lending facility.
84
February 2017) amount to just under EUR 1.4 trillion, which is at the very upper range of
likely SBBS market size in its early years.
Sovereign bond market liquidity can be proxied by price-based and volume-based
indicators. The analysis reports time variation in three liquidity indicators, two of which
are price-based and one of which is volume-based. In principle, the time variation in
these indicators provides suggestive evidence regarding the limited impact of PSPP on
sovereign debt market liquidity.
As a first indicator bid-ask spreads at daily frequency from January 2014 to February
2017 from MTS are obtained.64
Figure 6 plots these bid-ask spreads over time by
country. Visually, there is no apparent general level shift in bid-ask spreads following the
commencement of PSPP purchases in March 2015, denoted by the vertical black line in
the figure. Figure 7 plots the bid-ask spread against the fraction of outstanding central
debt securities held by the Eurosystem under the PSPP to shed more light on the
relationship between bid-ask spreads and the PSPP. Overall, both figures do not show
any systematic evidence that PSPP holdings are associated with increases in bid-ask
spreads. The only Member States where bid-ask spreads appear to increase somewhat are
Germany and Austria. In particular for Germany65
this has to be considered with caution,
given the relatively low turnover of German Bunds on the MTS platform.
Figure 6: Normalised bid-ask spreads in bps over
time
Figure 7: Average best daily bid-ask spreads
against the fraction of outstanding
government debt securities held by the
Eurosystem under the PSPP
Source: Report of the ESRB HLTF; Data: MTS. Source: Report of the ESRB HLTF; Data: MTS.
The second indicator is also price based and consists of a proprietary liquidity index
computed by Tradeweb66
. Figure 8 shows Tradeweb's index plotted against time while in
64
MTS is an interdealer platform, focussed on euro-denominated securities and serves as a backstop for dealers
who are unable to manage their inventory through customer relationships. MTS bid-offer spreads therefore
tend to be relatively static and wider than actual market spreads in the more liquid market segments. In the
MTS dataset, bid-ask spreads are measured in basis points as the difference between the best bid and ask
price posted on the domestic and European MTS platforms, normalised by the mid-price, and averaged over
each trading day. Bids and asks are posted with respect to benchmark 10-year national sovereign bonds.
65
This is consistent with the findings of Schlepper et al. (2017) regarding overall Bund scarcity.
66
Tradeweb is a request-for-quote trading platform focused on the dealer-to-customer market segment.
Differently to MTS data (where data are based on quotes) Tradeweb data are based on transaction prices, i.e.
those generated by actual trades. Tradeweb’s index is intended to measure liquidity levels within specific
85
Figure 9 it is plotted against the fraction of outstanding central government debt
securities held by the Eurosystem under the PSPP. Despite the higher volatility in the
Tradeweb index67
, there is no systematic upward trend in Tradeweb’s liquidity index
across countries. Nevertheless, in the case of some countries, there appears to be a slight
worsening in the liquidity index at the beginning of 2017.68
Figure 8: Tradeweb liquidity index over time Figure 9: Tradeweb liquidity index against the
fraction of outstanding government debt
securities held by the Eurosystem under
the PSPP
Source: Report of the ESRB HLTF; Data: Tradeweb. Source: Report of the ESRB HLTF; Data: Tradeweb.
Figure 10: Tradeweb volume indicator Figure 11: Tradeweb volume indicator against the
fraction of outstanding government debt
securities held by the Eurosystem under
the PSPP
Source: Report of the ESRB HLTF; Data: Tradeweb. Source: Report of the ESRB HLTF; Data: Tradeweb.
The third indicator is volume-based and computed against both time (Figure 10) and
against the fraction of outstanding central government debt securities held by the
Eurosystem under the PSPP (Figure 11). The variable is calculated as the ratio of the
day’s notional traded volume over the average daily notional traded volume over the
preceding 90 days. This ratio is then mapped to one of five categories, so that the
Tradeweb volume indicator is a categorical variable, which can take the value of any
fixed income markets, based on transaction prices relative to the mid-price. The vertical lines refer to
9 March 2015, the beginning of the PSPP.
67
Tradeweb’s index is more volatile because it is based on trade sizes that are generally much smaller and
variable in size than those on MTS, as they reflect customer requests-for-quotes from a smaller number of
dealers. By contrast, the MTS platform is a transparent limit order market which is very competitive.
68
The data sample ends early 2017. To fully assess this apparent development, it would be important to obtain
more recent data over 2017, given that PSPP holdings have continued to increase.
86
integer between 1 and 5 inclusive, where 1 corresponds to low turnover and 5 to high
turnover.69
Across countries, the average value of the volume indicator is 2.8 over 2014-
16, suggesting a mild reduction in volumes traded. However, there is no change over
time: the indicator stands at 2.8 in 2014, 2015 and 2016, i.e. before and after the
introduction of the PSPP. The fourth indicator illustrates the effect of liquidity via the
Hasbrouck ratio. This is the ratio of the logarithmic daily price difference over total
turnover. Figure 12 plots the Hasbrouck ratio over time and Figure 13 against PSPP
holdings. Again, this indicator is in line with the findings illustrated in the previous
figures: there is not an observable worsening of liquidity over the program.
Figure 12: Hasbrouck ratio over time Figure 13: Hasbrouck ratio against the fraction of
outstanding government debt securities
held by the Eurosystem under the PSPP
Source: Report of the ESRB HLTF; Data: Tradeweb. Source: Report of the ESRB HLTF; Data: Tradeweb.
Lastly, a regression analysis is performed to provide a more rigorous assessment of the
impact of PSPP on sovereign bond market liquidity. In particular, panel regressions are
estimated, with normalised bid-ask spreads regressed on time and country fixed effects,
as well as the magnitude of PSPP holdings.
The relationship between cumulative
bond purchases and normalised bid-ask
spreads is not linear. The model that
best describes the data is cubic in
nature. This means that normalised bid-
ask spreads (=dependent variable) are
regressed on the first, second and third
powers of cumulative PSPP purchases
("pspp_cogovdebt", "pspp_cogovdebt2", "pspp_cgovdebt3"), as well as time and country
fixed effects.70
69
In particular, a value of 1 corresponds to ratio of less than or equal to 0.8, i.e. a “very low” turnover on that
day relative to the preceding 90 days; a value of 2 corresponds to a ratio between 0.8 and 0.9, i.e. a “below
average” turnover; a value of 3 corresponds to a ratio between 0.9 and 1.1, i.e. “average” turnover; a value of
4 corresponds to a ratio between 1.1 and 1.2, i.e. “above average” turnover; and a value of 5 corresponds to a
ratio of more than 1.2, i.e. “very high” turnover.
70
The first three powers of the cumulative PSPP purchase, country and time dummies are the independent
variables.
Table 12: Results of fixed effects panel regression
Coefficient Standard
error
P-value
pspp_cgovdebt 0.0052111 0.00192 0.007
pspp_cgovdebt2 -0.0003711 0.0001223 0.002
pspp_cgovdebt3 0.0000104 0.00000273 0
Constant 0.17423696 0.0024821 0
Source: Report of the ESRB HLTF.
87
The results of the panel regression (see Table 12) indicate that, controlling for unreported
time and country fixed effects, the normalised bid-ask spreads are only slightly affected
by PSPP purchases. As is evident from the table, the effect of the programme on
normalised bid-ask spreads is statistically significant, yet only minor in terms of
economic magnitude, as the figure below reveals.
Figure 14 plots the predicted level of normalised bid-ask spreads for different levels of
PSPP purchases using the results of the regression above. Specifically, the red line plots
the forecasted normalised bid-ask spread of euro area sovereign bonds for different levels
of cumulative PSPP purchases71
. The dots depict the actual normalised bid-ask spread
observations for each country, net of the country and time fixed effects calculated in the
panel regression.
It is clear from the figure that the
impact of the PSPP on bid ask
spreads is low. The mean share of
PSPP purchases in February 2017,
across the countries in the sample,
was around 17%. For that value,
we can observe that the mean euro
area normalised spreads show a
very small increase, by
approximately 3 basis points. As
program purchases move toward
the issuer limit of 33%, the
regression model predicts a small
deterioration in liquidity: PSPP
holdings at the 26% mark is
associated with around 6 basis points increase in spreads. However, only 3 countries
surpassed the 20% mark by end of February 2017, and the red line extends to account for
the highest observed share of central government bond purchases (Germany at 26%).
The analysis above has shown that the impact of the PSPP on sovereign bond market
liquidity was limited. Only in some Member States normalised bid-ask spreads show a
minor to mild increase.72
71
The fitted values in the red line are a forecast of euro area aggregate normalised bid-ask spreads and are
estimated using the coefficients in Table 12 on different values of cumulative PSPP purchases across
countries for each month in the time series.
72
Overall, these findings are consistent with those of Schneider, Lillo and Pelizzon (2016), who analyse
sovereign bond market liquidity over 2015 (in the months immediately following the commencement of the
PSPP). They find that five and 10-year Italian sovereign bonds remained liquid and stable over 2015,
consistent with the stable bid-ask spreads plotted for Italy in Figure 6. However, they also find that 30-year
Italian sovereign bonds turned illiquid over the same period, which is consistent with the view that PSPP
may have somewhat larger effects on liquidity levels in already less liquid segments of the market. Similarly,
using a high-frequency, transaction-level analysis of Bundesbank purchases of German bonds in the
framework of the PSPP, Schlepper, Hofer, Riordan and Schrimpf (2017) find that the price impact of
purchases was stronger when markets were less liquid. However, the exception to this generally benign
finding is Germany, where PSPP purchases appear to have induced a temporary deterioration in market
liquidity over short periods. In their analysis of PSPP purchases of German bunds, Schlepper et al (2017)
find that bid-ask spreads widened for purchased securities, particularly when compared to non-eligible
Figure 14: Actual vs fitted values of normalised bid-ask
spreads net of country and time fixed effects,
plotted against cumulative share of central
government bond purchases under the PSPP
Source: Report of the ESRB HLTF.
88
Spillover effects
The following analysis – also performed by the ESRB HLTF73
– shows that given the
relative neutrality (as compared to the PSPP) with respect to duration74
, positive spillover
effects may arise from SBBS owing to their provision of (i) collateral services and (ii)
hedging opportunities, conditional on SBBS attaining adequate liquidity and a regulatory
level playing field for SBBS.75
Overall, assuming regulation does not penalise netting
excessively, there is in prospect a significant improvement in trading costs across all
European sovereign debt markets if SBBS effectively become benchmark securities.
(i) Provision of collateral services: While repo markets in sovereign bonds are well
developed, this would not necessarily be the case for SBBS. Such an active repo market
could however develop over time, once the SBBS market increases in size and the
necessary infrastructure has developed.
(ii) Provision of hedging opportunities: If SBBS are adequately liquid, banks and other
investors could use an SBBS portfolio to hedge short or long positions in sovereign
bonds. SBBS could serve as relatively low-cost hedging instruments with euro area wide
characteristics, and would be particularly valuable to dealer banks that provide quotes in
sovereign bond markets.
For the subsequent assessment the following assumptions and data are used:
- It is assumed that SBBS markets would be deeper and more liquid than smaller euro
area sovereign bond markets.
- Estimated SBBS yields, based on an approach developed by Schönbucher (2003)76
,
are used to examine the effects of hedging. The yield estimation method relies on a
simulated default-triggering mechanism and a market-based indicator of default
probability applied to the underlying securities. Figure 15 shows the time series
behaviour of yields on SBBS under two alternative subordination assumptions (a)
70:30 and b) 70:20:10) and of a selection of sovereign bond yields (c). All data used
in the analysis has been converted to price and then daily holding period returns,
with an assumed duration of 9 years.
- Hedging effectiveness of SBBS is assessed by measuring the magnitude and
stability of time-varying correlations between single SBBS (portfolios) and
individual sovereign bonds.
- Correlations are measured using a range of methodologies, including dynamic
conditional correlating using CDD-GJR-GARCH(1,1) modelling.
bonds, while market depth was somewhat reduced for purchased securities (up to EUR 1.6 million per
EUR 100 million purchased), compared to non-purchased eligible bonds.
73
See chapter 4.4.2 of volume II of the ESRB HLTF report.
74
The PSPP provides liquidity to financial markets by swapping medium- and long-term debt securities for
central bank reserves. By contrast, an SBBS programme would swap national debt securities for SBBS
securities of identical duration.
75
An example, where securitisation improves market quality more widely than seems plausible at first glance is
the "to-be-announced" Agency Mortgage Backed Securities market in the US. An analysis concludes that the
presence of the "to-be-announced" market has had widespread beneficial effects on liquidity even where
mortgage pools are not cheapest to deliver on the "to-be-announced" contract (Gao et al. (2017).
76
See section 1.4 of the ESRB HLTF report for details on the estimation of SBBS yields.
89
- Subsequently, diversification benefits are measured by comparing the variance of a
portfolio of hedged positions (with weights based on debt outstanding) compared
with the variances in the component markets. The hedge selection and assessment
follows closely the comprehensive approach of Bessler et al (2016).77
The results of the hedging effectiveness are presented in Table 13 – Table 15. The
effectiveness for each hedge is assessed by comparing (taking the ratio of) the hedged
and unhedged standard deviation of returns and Values-at-Risk (i.e. the average of the
ratio of the 5% and 95% Value-at-Risk). The results show that in the pre-sovereign debt
crisis period hedge effectiveness is high for all Member States (Table 13). The best
hedges are highlighted in bold. In the case of the single hedge, it is the senior-SBBS that
gives the best protection. In almost all cases of a combined hedge (2 tranches) provides
some marginal improvement in hedge effectiveness compared to the single tranche
hedge. In many cases the best overall hedge is achieved with a combination of the three
SBBS tranches, but this might not be worthwhile from a cost perspective. Table 14
shows the summary statistics for hedged/unhedged relative risks during the sovereign
debt crisis. For the single (senior) tranche hedge, only Germany remains well hedged.
Roughly half of the risk is avoided by single SBBS hedging for the case of Finland and
the Netherlands. The two and three tranche hedges generally lead to some small but
significant risk reduction for most sovereigns compared to the single tranche hedge.
Table 15 shows the results for the post-crisis recovery period (07/2012-Q4/2016). Using
composite hedging usually reduces the risks by half or more, with the exceptions of
Greece and Portugal.
The daily return on the hedged and unhedged positions for the case of hedging with just
the senior and for the case of hedging with a mixture of the senior and the mezzanine
tranche are shown in Figure 16 – Figure 18. The figures show in general that hedging is
very effective in the pre-sovereign debt crisis period in reducing the variance of returns
(with some isolated exceptions). Hedging is not effective for high-risk sovereigns during
the height of the sovereign debt crisis but effectiveness returns to some extent during the
recovery. In general the combined hedge works better than the single hedge in the crises
and recovery periods. As regards particular countries, Figure 16 shows that hedging is
quite consistently effective for core countries (DE, FR and NL, and the same counts for
AT and FI which are not displayed). In these cases, the composite hedge seems to
eliminate the occasional blips present in the single hedge case. For non-core Member
States results are less clear: Figure 17 shows the cases of BE, ES and IT and clearly
reveals how idiosyncratic the effects are during the crisis. It is interesting that the
composite hedge (senior and mezzanine) works better than the single hedge during the
crisis and recovery (apart from one particular day). This tends to improve further with the
inclusion of the junior SBBS as a hedge instrument (this more general case is not
displayed in the figure but can be seen from the tabulated results yet to be discussed).
Figure 18 shows the more volatile cases of GR, IE and PT. There is also evidence of
hedge ineffectiveness during the crisis with improvement only obvious during the
recovery for IE and PT. Again, the composite hedge is better than the single hedge during
the recovery for these countries and is particularly good in protecting from the more
77
See section 4.4.2 of the ESRB HLTF report for further model details, used data and results.
90
extreme movements. Although hedging is often ineffective in these cases one has to
acknowledge that these are small markets and their idiosyncratic riskiness could easily be
diversified as part of a cross-country portfolio.
Figure 15: Estimated yields on SBBS and selected sovereigns (%)
a) 70:30 SBBS Yields
b) 70:20:10 SBBS Yields
c) Yields of DE, IT, GR & PT
Source: ESRB HLTF report. Note: Shaded area is euro area Sovereign Debt Crisis period (11/2009-08/2012).
91
Table 13: Hedge Effectiveness: Pre-Sovereign Debt Crisis
Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged
returns relative to the unhedged returns.
Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr
AT(i) 0.38 0.39 0.65 0.33 0.3 0.5 0.28
AT(ii) 0.27 0.28 0.65 0.23 0.18 0.43 0.16
BE(i) 0.35 0.37 0.64 0.28 0.25 0.48 0.23
BE(ii) 0.29 0.3 0.63 0.24 0.2 0.42 0.17
DE(i) 0.21 0.22 0.68 0.16 0.16 0.54 0.13
DE(ii) 0.15 0.19 0.69 0.14 0.12 0.51 0.11
ES(i) 0.45 0.45 0.64 0.38 0.34 0.47 0.31
ES(ii) 0.38 0.39 0.64 0.31 0.27 0.42 0.25
FI(i) 0.3 0.31 0.65 0.28 0.25 0.54 0.24
FI(ii) 0.21 0.23 0.64 0.19 0.16 0.47 0.16
FR(i) 0.28 0.29 0.63 0.22 0.2 0.47 0.17
FR(ii) 0.24 0.25 0.63 0.19 0.16 0.41 0.12
GR(i) 0.64 0.67 0.73 0.54 0.49 0.51 0.45
GR(ii) 0.54 0.56 0.67 0.4 0.4 0.42 0.33
IE(i) 0.58 0.6 0.74 0.53 0.49 0.61 0.48
IE(ii) 0.34 0.38 0.67 0.3 0.28 0.48 0.28
IT(i) 0.5 0.53 0.65 0.37 0.35 0.41 0.28
IT(ii) 0.44 0.5 0.63 0.31 0.3 0.36 0.23
NL(i) 0.31 0.32 0.63 0.25 0.22 0.46 0.19
NL(ii) 0.23 0.25 0.64 0.2 0.17 0.42 0.14
PT(i) 0.5 0.52 0.66 0.41 0.37 0.46 0.33
PT(ii) 0.38 0.4 0.62 0.31 0.27 0.39 0.23
92
Table 14: Hedge Effectiveness: Sovereign Debt Crisis
Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged
returns relative to the unhedged returns.
Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr
AT(i) 0.76 0.89 1 0.68 0.84 1.04 0.74
AT(ii) 0.68 0.81 0.98 0.59 0.61 0.95 0.59
BE(i) 0.97 0.96 0.98 0.73 1.1 0.84 0.8
BE(ii) 0.98 0.98 1 0.73 0.9 0.83 0.71
DE(i) 0.32 1 1.07 0.28 0.33 1.04 0.29
DE(ii) 0.31 1.04 1.05 0.27 0.31 0.95 0.27
ES(i) 1.01 1.1 1.01 0.67 1.1 0.69 0.72
ES(ii) 0.97 1.15 1.05 0.71 0.87 0.66 0.65
FI(i) 0.48 0.93 1.03 0.48 0.51 1.06 0.53
FI(ii) 0.46 0.96 1.02 0.46 0.46 1.04 0.45
FR(i) 0.77 0.88 1 0.65 0.85 1 0.69
FR(ii) 0.7 0.88 1.02 0.62 0.68 1.02 0.62
GR(i) 1 1.01 1 1 0.85 0.85 0.83
GR(ii) 0.96 1.13 1.11 1.02 1.26 1.28 1.23
IE(i) 1.02 1.07 1.02 0.97 1.01 0.98 1.01
IE(ii) 0.99 1.06 1.03 0.95 0.92 0.93 0.94
IT(i) 1 1.1 1.01 0.56 1.18 0.61 0.63
IT(ii) 1.02 1.13 1.03 0.6 0.91 0.57 0.56
NL(i) 0.51 0.91 1.02 0.52 0.54 1.07 0.57
NL(ii) 0.47 0.94 1.05 0.48 0.48 1.03 0.49
PT(i) 1.01 1.05 1.01 0.99 1.01 0.98 1
PT(ii) 1.01 1.02 1.01 0.95 0.9 0.92 0.91
93
Table 15: Hedge Effectiveness: Post-Sovereign Debt Crisis
Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged
returns relative to the unhedged returns.
Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr
AT(i) 0.55 0.78 1 0.53 0.51 0.9 0.51
AT(ii) 0.49 0.75 1 0.47 0.43 0.86 0.44
BE(i) 0.56 0.74 0.98 0.52 0.47 0.87 0.48
BE(ii) 0.5 0.72 0.97 0.47 0.43 0.85 0.43
DE(i) 0.27 0.87 1.04 0.26 0.27 0.92 0.25
DE(ii) 0.28 0.9 1.04 0.27 0.27 0.93 0.26
ES(i) 0.98 1.02 0.97 0.68 0.74 0.58 0.57
ES(ii) 0.96 0.94 0.96 0.71 0.72 0.59 0.57
FI(i) 0.48 0.84 1.01 0.47 0.45 0.91 0.45
FI(ii) 0.41 0.82 1.01 0.4 0.38 0.89 0.38
FR(i) 0.5 0.73 0.98 0.45 0.42 0.85 0.41
FR(ii) 0.46 0.72 0.98 0.44 0.39 0.84 0.39
GR(i) 1 1.07 1.07 0.92 0.92 1.02 0.92
GR(ii) 1.05 1.06 1.08 1.03 1.11 1.17 1.12
IE(i) 0.9 0.89 0.97 0.79 0.78 0.81 0.73
IE(ii) 0.86 0.83 0.95 0.71 0.72 0.77 0.65
IT(i) 0.97 1.01 0.96 0.59 0.72 0.5 0.47
IT(ii) 0.93 0.95 0.96 0.59 0.66 0.48 0.46
NL(i) 0.47 0.82 1.01 0.46 0.44 0.91 0.44
NL(ii) 0.4 0.82 1 0.39 0.36 0.89 0.35
PT(i) 1 1.02 1 0.87 0.85 0.79 0.79
PT(ii) 0.99 1.02 1 0.87 0.83 0.75 0.74
94
Figure 16: Single & Composite Hedging (DE, FR, NL) – returns measured in bps (left axis)
(a) DE: Single (senior) Hedge (b) DE: Composite (sen+mez) Hedge
(c) FR: Single (senior) Hedge (d) FR: Composite (sen+mez) Hedge
(e) NL: Single (senior) Hedge (f) NL: Composite (sen+mez) Hedge
Source: ESRB HLTF report.
95
Figure 17: Single & Composite Hedging (BE, ES, IT) – returns measured in bps (left axis)
(a) BE: Single (senior) Hedge (b) BE: Composite (sen+mez) Hedge
(c) ES: Single (senior) Hedge (d) ES: Composite (sen+mez) Hedge
(e) IT: Single (senior) Hedge (f) IT: Composite (sen+mez) Hedge
Source: ESRB HLTF report.
96
Figure 18: Single & Composite Hedging (GR, IE, PT) – returns measured in bps (left axis)
(a) GR: Single (senior) Hedge (b) GR: Composite (sen+mez) Hedge
(c) IE: Single (senior) Hedge (d) IE: Composite (sen+mez) Hedge
(e) PT: Single (senior) Hedge (f) PT: Composite (sen+mez) Hedge
Source: ESRB HLTF report.
97
4. IMPACT ON THE VOLUME OF AAA ASSETS
An estimation of the impact of the introduction of SBBS on the volume of AAA assets
available in the euro area has been carried out to compare the respective benefits of a
tranched product ('SBBS proper', i.e. Models 1 and 2) and the untranched basket (per
Model 5).
The calculation is based on Eurostat data on euro area central government debt as of
December 201678
, as well as Standard & Poor's ratings of euro area sovereign
governments on the same date79
.
The composition of the SBBS portfolio is based on the ECB capital key for each euro
area government. Two scenario are considered: a scenario where SBBS develop
gradually and reach a limited volume only (Limited volume scenario), and a steady state
scenario with significant volumes of SBBS.
The estimation is based on a static approach, whereby the impact of the SBBS
introduction is assessed against the volumes of central government debt as of 2016.
While this approach ignores the future evolution of (i) central government debt stocks
and (ii) euro area sovereign ratings over the forthcoming years, it nevertheless allows for
a robust comparison of the expected effects of options 1.2 and 1.3.
The analysis assumes that the senior tranche of the 'SBBS proper' will be granted an
AAA rating, while an untranched basket would not. The results are displayed in
Table 16.
Table 16: Impact of the SBBS on the volume of AAA assets in the euro area
(% of EA government debt rated AAA) Limited volume scenario Steady state scenario
SBBS proper (Models 1 and 2) +2% +30%
Basket (Model 5) -2% -25%
Source: European Commission
As shown in Table 16, the impact is negligible in the limited volume scenario (Year 5
after a gradual introduction), while in the steady state it could increase the amount of
euro area sovereign debt rated AAA by up to 30%, subject to the tranching of the SBBS
product. Indeed, a mere basket would conversely negatively impact the amount of EA
government debt rated AAA by 25% in the steady state scenario, since the basket is not
expected to be rated AAA.
78
Downloaded from Eurostat website on 21 December 2017 at 10:42.
79
Downloaded from S&P website on 21 December 2017.
98
5. IMPACT ON THE COMPOSITION OF BANKS' SOVEREIGN PORTFOLIOS
The impact of the introduction of the SBBS on banks' sovereign portfolios has been
assessed under both the limited volume scenario and the steady state scenario. This
calculation does not assess separately the SBBS proper from the basket, since the
diversification effect is assumed to be similar.
Using the data of the EBA transparency exercise as of 30 June 2017 and the latest ECB
capital key, the analysis calculates, for each bank in the sample (96 banks of the euro
area), the reduction in domestic holdings if banks decided to switch some of their
domestic holdings for new SBBS bonds. For sake of simplicity, it is assumed that each
bank would switch a proportion of its euro area sovereign portfolio similar to the overall
ratio of SBBS relative to the universe of euro area central government bonds, in each
scenario. It is also assumed that banks would only switch domestic government bonds
insofar as their weight in the bank's portfolio exceeds the capital key of that government
(home bias).
Table 17: Impact of the SBBS on the diversification of banks' sovereign portfolios
(Reduction of domestic holdings in %) Limited volume scenario Steady state scenario
SBBS proper (Models 1 and 2) -3% -34%
Source: European Commission
Table 17 shows that the impact would be small in the limited volume scenario, but
significant under the steady state scenario. Under those assumptions, the home bias in the
sample of euro area banks covered by the EBA transparency exercise would be reduced
by 42%.
Using the same sample of bank and the same assumptions, the impact of the introduction
of SBBS on the amount of AAA assets held in banks' sovereign portfolios is assessed.
The analysis is carried out for three models: model 1, model 2 and model 5. It is assumed
in model 2 that banks would only hold the senior tranche of the SBBS proper, while in
model 1 they would hold all the tranches. The junior and mezzanine tranches of the
SBBS proper (model 1 and 2) as well as the basket (model 5) are expected to be rated
below AAA.
Table 18: Impact of the SBBS on the amount of AAA assets in banks' sovereign portfolios
(share of sovereign holdings rated AAA in %) Actual Model 1 Model 2 Model 5
Limited volume scenario 24% 24% 24% 23%
Steady state scenario 24% 32% 33% 19%
Source: European Commission
As reported in Table 18, the impact would be negligible in the limited volume scenario,
and noticeable and positive in the steady state scenario for the SBBS proper option
(model 1 and 2), while it would be negative in the case of baskets (since the share of
AAA sovereign assets would drop from 24% to 19%).


EN EN
EUROPEAN
COMMISSION
Brussels, 29.6.2018
SWD(2018) 252 final/2
CORRIGENDUM
This document corrects SWD(2018) 252 final of 24.5.2018.
This version corrects a mistake in Figure 3 on page 9, specifically: the ECB original capital
key for France should have read 0.142 rather than 0.242. The other values in the table which
depend via algebraic manipulation on this entry are also suitably corrected.
The text should read as follows:
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT
An enabling regulatory framework for the development of sovereign bond-backed
securities (SBBS)
Accompanying the document
Proposal for a Regulation of the European Parliament and of the Council
on sovereign bond-backed securities
{COM(2018) 339 final} - {SEC(2018) 251 final} - {SWD(2018) 253 final}
Europaudvalget 2018
KOM (2018) 0339
Offentligt
1
Table of contents
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT............................................................... 4
2. PROBLEM DEFINITION .................................................................................................................... 9
2.1. What is the problem?.........................................................................................9
2.2. What are the problem drivers? ........................................................................12
2.3. How will the problem evolve? ........................................................................15
3. WHY SHOULD THE EU ACT? ........................................................................................................ 16
3.1. Legal basis.......................................................................................................16
3.2. Subsidiarity (Necessity of EU action) .............................................................17
3.3. Subsidiarity (Value added of EU action).........................................................17
4. OBJECTIVES: WHAT IS TO BE ACHIEVED? ............................................................................... 17
4.1. General objectives ...........................................................................................17
4.2. Specific objectives...........................................................................................18
5. WHAT ARE THE AVAILABLE POLICY OPTIONS? .................................................................... 19
5.1. What is the baseline from which options are assessed? ..................................19
5.2. Description of the policy options ....................................................................22
5.3. Options discarded at an early stage .................................................................23
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? ........................................................... 24
6.1. Scenarios and benchmarks of benefits and costs.............................................24
6.1.1. Scenarios ............................................................................................................... 24
6.1.2. Benchmarks of benefits and costs ......................................................................... 24
6.2. Scope of applicability of the proposed legislation ..........................................25
6.2.1. Option 1.1: only SBBS proper .............................................................................. 25
6.2.2. Option 1.2: All securitisations of euro area sovereign bonds................................ 27
6.2.3. Option 1.3: A basket of euro-are sovereign bonds (with weights according to the
official "SBBS recipe") ......................................................................................................... 28
6.2.4. Impact summary and conclusions ......................................................................... 30
6.3. Extent of ’restored’ regulatory neutrality........................................................31
6.3.1. Option 2.1: Extend the regulatory treatment of euro area sovereign bonds to all
tranches 32
6.3.2. Option 2.2: Extend the regulatory treatment of euro area sovereign bonds only to
senior tranches....................................................................................................................... 33
6.3.3. Impact summary and conclusions ......................................................................... 34
6.4. Ensuring compliance with SBBS criteria and consistency in
implementation................................................................................................34
6.4.1. Option 3.1: A compliance mechanism based on self-attestation........................... 35
6.4.2. Option 3.2: Option 3.1, with the involvement of third-parties.............................. 37
2
6.4.3. Option 3.3: Option 3.1 with ex-ante supervisory checks on each issuance........... 38
6.4.4. Impact summary and conclusion........................................................................... 39
7. HOW DO THE OPTIONS COMPARE?............................................................................................ 40
8. PREFERRED OPTION ...................................................................................................................... 43
8.1. Preferred model ...............................................................................................43
8.2. REFIT (simplification and improved efficiency) ............................................43
9. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?.................................. 43
LIST OF REFERENCES.............................................................................................................................. 45
ANNEX 1 PROCEDURAL INFORMATION ......................................................................................... 47
1. LEAD DG, DECIDE PLANNING/CWP REFERENCES.................................................................. 47
2. ORGANISATION AND TIMING...................................................................................................... 47
3. CONSULTATION OF THE RSB....................................................................................................... 47
4. EVIDENCE, SOURCES AND QUALITY......................................................................................... 47
ANNEX 2 STAKEHOLDER CONSULTATION .................................................................................... 48
1. RESULTS FROM THE ESRB PUBLIC SURVEY ON SOVEREIGN BOND-BACKED
SECURITIES...................................................................................................................................... 48
1.1 Senior SBBS....................................................................................................48
1.2 Junior SBBS ....................................................................................................52
1.3 Regulation........................................................................................................56
1.4 Economics of SBBS issuance..........................................................................58
2. SUMMARY OF THE INDUSTRY WORKSHOP............................................................................. 62
Session 1: Motivation................................................................................................63
Session 2: Sovereign debt markets............................................................................64
Session 3: Commercial banks....................................................................................65
Session 4: Non-bank Investors..................................................................................66
Session 5: Demand for junior SBBS .........................................................................67
Session 6: Risk measurement....................................................................................67
3. MAIN TAKEAWAYS OF THE CLOSED-DOOR DMO WORKSHOP .......................................... 68
ANNEX 3 WHO IS AFFECTED AND HOW?........................................................................................ 69
1. PRACTICAL IMPLICATIONS OF THE INITIATIVE..................................................................... 69
2. SUMMARY OF COSTS AND BENEFITS ....................................................................................... 73
ANNEX 4 ANALYTICAL METHODS................................................................................................... 79
1. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT PRESENT ............... 79
2. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT POST
1/1/2019 .............................................................................................................................................. 81
3. PRESENTATION OF THE ANALYSIS BY THE ESRB LIQUIDITY WORKING GROUP
ON THE EFFECTS OF SBBS ON NATIONAL SOVEREIGN BOND MARKET
LIQUIDITY ........................................................................................................................................ 82
4. IMPACT ON THE VOLUME OF AAA ASSETS ............................................................................. 97
5. IMPACT ON THE COMPOSITION OF BANKS' SOVEREIGN PORTFOLIOS ............................ 98
3
Glossary
Term or acronym Meaning or definition
AIFMD Alternative Investment Fund Managers
BRRD Bank Recovery and Resolution Directive (Directive 2014/59/EU)
CCP Central Counter Parties
CET1 Core Tier-1 Capital
CIU Collective Investment Unit/Undertaking
CRD Capital Requirement Directive IV (Directive 2013/36/EU)
CRR Capital Requirement Regulation (Regulation (EU) 575/2013)
CSD Central Securities Depositories
DMO Debt Management Office
EBA European Banking Authority
ECB European Central Bank
EIOPA European Insurance and Occupational Pensions Authority
EMU Economic and Monetary Union
ESM European Stability Mechanism
ESRB European Systemic Risk Board
EU European Union
HLTF High Level Task Force
HQLA High-Quality Liquid Assets
IORP Institutions for Occupational Retirement Provision
IRB bank A bank using "Internal Ratings-Based" models to calculate its capital requirements
LCH London Clearing House
LCR Liquidity Coverage Ratio
NSFR Net Stable Funding Ratio
RTSE Regulatory Treatment of Sovereign Exposures
SA bank A bank using the "Standardised Approach" to calculate its capital requirements
SBBS Sovereign Bond-Backed Securities
SCR Solvency Capital Requirement
SPV Special purpose vehicle
SSM Single Supervisory Mechanism
STS securitisation Simple, transparent and standardised securitisation
TFEU Treaty on the Functioning of the European Union
UCITS Undertakings for Collective Investment in Transferable Securities
4
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT
A novel concept—that of Sovereign Bond-Backed Securities, or SBBS (see Box 11
)—
has attracted the attention of academics and policy makers alike as a possible tool to
address the "home bias" in banks' sovereign portfolios (see Box 2) and further weaken
the banks-sovereign nexus (see Box 3), two vulnerabilities that were at the heart of the
last financial and economic crisis.
SBBS are appealing because, by design, they would not suffer from some of the pitfalls
associated with other widely discussed reforms to address these key vulnerabilities, e.g.
the introduction of Eurobonds2
and a reform of the regulatory treatment of sovereign
exposure (RTSE) to discourage concentrated investment in sovereign bonds, especially
of the riskier ones. Specifically:
1. Differently from Eurobonds, SBBS would not involve mutualisation of risks and
losses among Member States. Risk/loss mutualisation is seen as problematic by
many because it might encourage moral hazard.
2. SBBS do not present the same risks for financial stability as would stem from an
untimely RTSE reform. It is precisely to ward off such financial stability risks that
the Commission's stance on RTSE, as reiterated e.g. in the May 2017 Reflection
Paper3
on deepening the economic and monetary union (EMU), is that it can only
happen once Banking Union, Capital Markets Union, and a European safe asset are
in place (section 2.3).
SBBSs are tranches issued against a diversified portfolio of euro-area central government
bonds. The diversification of the underlying portfolio and the conservative tranching
threshold (i.e., a sufficiently large loss-absorbing sub-senior tranche) would ensure a very
high level of safety for the senior tranche. The tranching would in effect concentrate
sovereign risk into the junior and, to a lesser extent, mezzanine tranches. If the latter two
tranches are bought by investors whose losses are less likely (than, say, those of banks)
to create spillovers to the public purse, the risk of feedback loops in case of stress in one
or more euro area sovereigns would be further reduced.4 5
An inter-institutional High Level Task Force (HLTF) was established in mid-2016 under
the aegis of the ESRB and the Chairmanship of Central Bank of Ireland Governor
Philip Lane to assess the feasibility, merits and risks of SBBSs. The European
Commission (henceforth, the Commission) has actively contributed to the work of this
task force, which also comprised representatives from 16 national central banks, the
ECB, the EBA, the EIOPA, as well as of Member States' Debt Management Offices and
academics (for the list of HLTF members, see Annex 1 of the HLTF report).
1
See also Brunnermeier et al. (2016b).
2
A classical Eurobond is a bond guaranteed jointly and severally by all participating Member States.
3
https://ec.europa.eu/commission/publications/reflection-paper-deepening-economic-and-monetary-union_en
4
An alternative way to pool sovereign bonds would be in a basket with a specific composition, which would be
equivalent to a securitisation with a single junior tranche (see section 6.2.3).
5
Of course, SBBS would per se not achieve the optimal overall diversification of banks' balance sheets. They
can help diversify banks' sovereign exposures. To the extent that banks also diversify geographically their
other assets (i.e., through cross-border lending to non-financial corporates and households) the sovereign-
bank nexus would be further weakened.
5
Based on the work conducted by the HLTF and its own analysis, in the above mentioned
May 2017 Reflection paper on deepening EMU, the Commission has put forward SBBS
as a possible tool that could be launched in the short term6
to enhance diversification of
banks' sovereign exposures.
In the Letter of Intent accompanying his 2017 State of the Union Address,
President Juncker has committed the Commission to propose by 2018 an "enabling
framework for the development of SBBS to support further portfolio diversification in
the banking sector."
Finally, in its October 2017 Banking Union Communication, the Commission reiterated
its view that SBBS "have the potential to contribute to the completion of the Banking
Union and the enhancement of the Capital Markets Union" by "support(ing) further
portfolio diversification in the banking sector, while creating a new source of
high-quality collateral particularly suited for use in cross-border financial transactions".
On this basis, the Communication notes that "building on the outcome of the [ESRB
HLTF] work in December 2017 and consultations with relevant stakeholders, the
Commission will consider putting forward a legislative proposal for an enabling
framework for the development of sovereign bond-backed securities in early 2018."
The HLTF has concluded7
that, while they would not address fully all the known
structural vulnerabilities of the euro area financial sector, SBBSs do have potential to
improve on the status quo. However, SBBS are unlikely to emerge under the current
regulatory framework, since the latter would impose on them additional charges and
discounts (relative to those faced by the sovereign bonds in the underlying portfolio),
making SBBS uneconomical to produce and unattractive to hold (see section 2.1).
The HLTF found that a gradual development of a demand-led market for SBBS may be
feasible under certain conditions.8
A key necessary condition, however, is for
an SBBS-specific enabling legislation to provide the conditions for a sufficiently large
investor base, including both banks and non-banks.
This impact assessment studies, therefore, whether and how to adapt the current
regulatory framework to better take into account the features and properties of these
novel instruments. Doing so would make it possible for SBBS to undergo a true "market
test", which is the only way to ascertain whether they are economically feasible or not
once relieved of the existing regulatory hindrances.
6
Other measures, such as a European safe asset, would require more analysis and more time (again, see EMU
reflection paper).
7
The final report is available at https://www.esrb.europa.eu/pub/task_force_safe_assets/html/index.en.html.
8
Many market participants have argued strongly that the viability of SBBSs would be greatly enhanced if the
junior tranches were supported by some form of public guarantee (for example replies to the public survey,
Annex 2, section 1 and DMO's views, annex Annex 2, section 3). As discussed below (see section 5.3), there
is no appetite to offer such guarantees. Indeed the key feature of SBBS, which has gained them support
among a cross-section of policymakers, is precisely that they would not involve any public support, and that
they would rather rely exclusively on mutualisation of risks among private investors.
6
9
Of course, no asset can be made to be fully safe. The analysis by the HLTF shows that a 70-percent thick senior
tranche would have a five-year expected loss rate of 0.5% or less ("at least as safe as German Bunds").
Box 1: The concept of SBBS
SBBS consist of different claims (tranches) of ranked seniority on an underlying diversified portfolio
of (euro area) sovereign bonds put together by a Special Purpose Vehicle (SPV) (see Figure 1).
Depending on how the market would develop, one or several arrangers would issue the
instrument. The weights of the various sovereign bonds in the underlying portfolio would be fixed (e.g., in
line with each country's GDP, or the ECB key), as would their tranching structure (i.e., number of
tranches—e.g., a senior, a mezzanine and a junior tranche—and tranching points). The portfolio would
initially cover central government bonds of euro
area countries. The scheme could start off at a
relatively small scale, and would be envisaged to
cover up to a fraction of Member States' bonds,
so as to leave a balance of national bonds in the
market, for market discipline purposes. As
mentioned, SBBS would be different from
classical Eurobonds in that they would not rely
on any risk sharing or fiscal mutualisation
between Member States.
Figure 1: Balance sheet of a special-purpose
vehicle issuing SBBS with three tranches
By virtue of this tranching with seniority, the
junior tranche would be first in line to take
any losses that might arise in the tail event of
a sovereign default. With an appropriate
tranching point, the intention is that the
senior tranche would constitute "safe" or low-risk assets.9
SBBS, and in particular the senior tranche, could potentially yield tangible benefits for the overall
financial architecture in Europe. In particular, they would help:
 Allow banks and other investors to diversify their sovereign bond portfolios—whose home
bias is presently a key conduit of the sovereign-bank nexus—at relatively low transaction
costs. This would thus help avoid the financial fragmentation observed over the course of the
sovereign debt crisis, when yield differences between euro area Member States widened.
With SBBS, safe haven flows would move also across instruments (i.e. from the junior to the
senior tranche) rather than just across borders (i.e., from sovereigns with weaker fiscal
positions to those with stronger ones.
 Alleviate safe asset scarcity in Europe: Expand the supply of (euro-denominated) "safe"
(high-rated) assets, which has been falling due to the many downgrades experienced in the
wake of the crisis, against the regulation-induced increased demand for high-quality liquid
assets, especially in the context of the Liquidity Coverage Ratio (LCR). Importantly, all
qualifying euro area Member States would indirectly contribute to such a high-rated asset.
So the gains from the "exorbitant privilege" of producing safe assets would be more evenly
shared than is the case now.
 Create a risk-free rate benchmark curve against which other securities could be priced.
 Create an asset that the ECB could use, if they so choose, to conduct monetary policy
operations without risking been perceived as supporting a particular Member State.
Basing the SBBS' underlying portfolio on the ECB key has several objectives:
 First, it is meant to ensure that the benefits (and any costs) associated with the expanded
supply of low risk assets accrue in a balanced manner to all euro area Member States. This is
an important consideration, not just in point of fairness, but also in terms of efficiency.
Specifically, if SBBS manage to become a ’benchmark’-like security, they (in particular
their senior tranche) may be used by investors as a low-risk alternative to build or to unwind
Assets Liabilities
Junior tranche
Euro area (central)
government bonds
(e.g., ECB capital key
weights)
Senior Tranche
Mezzanine trance
7
Box 2: The bank-sovereign nexus
Sovereign and banking stress can reinforce each other through a number of channels,
especially in times of economic stress. A worsening of the financial situation of the sovereign
leads to deterioration in the market value of government debt, including that held by the banks,
reducing their loss absorption capacity (at market prices) and hindering their ability to lend to the
economy.10
In turn, this further depresses economic activity, lowering tax revenue and adding to
the funding pressure on the sovereign. In the past, the state was furthermore perceived to provide
the ultimate backstop to ensure banking stability, either by injecting capital or by providing
liquidity. Therefore, banking stress increased the contingent liabilities for the government, raising
its financing costs. This further exacerbated the feedback loop.11
Figure 2: The bank-sovereign nexus
Source: Brunnermeier et al. (2016b)
The sovereign-bank nexus was one of the main factors amplifying financial distress in the
euro area during the last financial and economic crisis. High stock of public debt in Greece
and Italy combined with increased exposure of these countries' banking sectors (and, in the case
of Greece, of Cypriot banks also) to sovereign finances. Meanwhile, imprudent lending practices
by Irish, Spanish and Slovenian banks built up high and in some cases excessive risk on bank
10
This channel is exacerbated in countries with high levels of government debt or where there is prevalent home
bias in banks' sovereign portfolios (Box 3).
11
For a more detailed discussion, also Banca d'Italia (2014).
positions in euros. This means, for example, that if there is an increase in the demand for
’low risk’ euro exposures, investors could purchase the (senior) SBBS rather than the bonds
of the (select) high rated euro-area Member States. As a result, any downward pressure on
interest rates would be spread throughout the euro area, and not skewed to benefit only a few
Member States and the borrowers in these jurisdictions. This is positive for Member States
that would otherwise not benefit from this enhanced demand for euro exposure, and also for
high-rated Member States, which otherwise could experience unduly low interest rates,
potentially leading in turn to overheating, misallocation of investment, as well as to
challenges for some investor classes (e.g., pension funds).
 Second, it is meant to facilitate standardisation of SBBS over time, as the ECB key is
relatively stable (especially if applied on multi-year averages of the underlying determinants,
e.g. population and GDP levels).
 Finally, it is meant to avoid potential moral hazard associated with other likely candidates for
standardised portfolio composition, and in particular with the relative share of outstanding
individual governments' debt on the total (as countries with larger debt stocks would then
benefit disproportionately).
8
balance sheets, and subsequent public intervention put significant strain on the finances of their
respective sovereigns.12
The concomitant hikes in funding costs put significant strain on
economic activity in these countries.
Thus, addressing this feedback loop enhances financial stability and increases resilience.
Mitigating the link between sovereign and financial stress through prudent policy making, greater
asset diversification and building up credible backstops, would reduce the overall level of risk in
the economy. In turn, this would limit the cost of sunspot-driven crises, thereby enhancing
financial stability.
Several important steps have been taken in recent years towards a full Banking Union, thus
weakening the bank-sovereign nexus. For example, (major) euro-area banks are now
supervised at the EU level (by the SSM) and (if necessary) resolved by the Single Resolution
Mechanism supported by the Single Resolution Fund. Furthermore, a backstop for the Single
Resolution Fund is being established, which means that banks can be resolved efficiently and
effectively, irrespective where they are headquartered. Furthermore, the Commission has
proposed the establishment of a backstop to the Single Resolution Fund, to be provided by the
ESM, or the (future) European Monetary Fund.13
Box 3: The home bias in banks' sovereign portfolios
A key factor that strengthens the link from a sovereign to its banks is the so-called "home
bias" in banks' sovereign bond portfolios, i.e. banks are typically most exposed to their own
sovereign. This home bias actually increased in the wake of the euro area debt crisis, in particular
in more vulnerable Member States, even if more recently, also supported by government bond
purchases by the ECB, banks have somewhat reduced their holdings of government bonds.
The table in Figure 3 reports the size of banks' holdings of bonds of their own sovereign in EU
Member States, both in nominal value as a share of banks' overall sovereign bond portfolios.
When this share is disproportionately large (for example, compared to the Member State's share
in the ECB capital key), it gives rise to so-called "home bias".
As shown in Figure 3, the degree of "home bias" is not homogenous within the euro area, with
the share of exposure to the home sovereign relative to the total of sovereign exposures ranging
from 8.3% (Luxembourg) to 61.3% (Slovenia) in the sample. This share is generally well above
each Member States' share in the ECB capital key, except for French banks.14
Several factors can explain why a bank would prefer holding bonds issued by its home
sovereign. The first one is simply the better knowledge of the home sovereign's creditworthiness
(see Persaud (2017)), compared to that of more remote sovereigns. Another one refers to possible
differences in perceived default probabilities: investors (and banks in particular) might believe
that a sovereign in financial difficulty may try to prioritise servicing its domestic debt (and in
particular, domestic banks) over bonds held by foreign investors (see Guembel and Sussman
(2009)). In addition, banks may also accumulate domestic sovereign exposure if they consider
that the additional risk of holding such debt is negligible: if the home sovereign was to fail, the
bank is likely to fail anyway, since its exposures to the domestic economy are likely to sour.15
Finally, domestic banks may be subject to "moral suasion". In particular, government-owned
12
See Erce. A (2015) for a discussion of the factors which affect the extent of spillovers from banks to the
sovereigns, such as the size of the banks' balance sheets, the structure of their liabilities, and the level of non-
performing loans.
13
https://ec.europa.eu/commission/publications/completing-europes-economic-and-monetary-union-
factsheets_en
14
Recent data show a reduction in euro area banks' holdings of government debt by 17% between 2015 and
2017, which thus also reduces their financial connection with their sovereign.
15
As Horváth, B L, H Huizinga, and V Ioannidou (2015) put it: "additional domestic sovereign exposure cannot
hurt them (banks) much, because they are likely to fail anyway if their sovereign defaults".
9
banks and banks under political influence (through government seats at the Board of directors)
report higher home bias in sovereign debt, and such moral suasion is stronger in countries under
stress (see De Marco and Macchiavelli (2016)).
Figure 3: Banks' exposure to domestic sovereign bonds as of 30 June 2016
Source: EBA 2016 Transparency Exercise; ECB (for capital key)
Notes: 1/ Rebased to 100 using only listed Member States; 2/ difference between figures in third and fifth columns.
Some commentators have associated banks' home bias in sovereign exposure with the regulatory
treatment of sovereign exposures, since sovereign debt denominated in the domestic currency is
considered risk-free, providing banks with strong incentives for holding such bonds. However,
this doesn't explain the prevalence of the home bias in the euro area, since all sovereign bonds
from euro area countries are treated in the same way for euro area banks.
2. PROBLEM DEFINITION
2.1. What is the problem?
The problem that the proposed initiative would address is that the current regulatory
framework impedes the development by the private sector of SBBS.
This is because, under the current regulatory framework, SBBSs would be treated as
securitisation products, and hence significantly less favourably—along several
dimensions—than their underlying portfolio of euro area sovereign bonds (see Box 4).
For example, banks would face lower capital requirements (indeed, zero) by holding the
underlying sovereign bonds rather than SBBS tranches. Moreover, whereas banks
currently extensively use euro area sovereign bonds for the purposes of meeting liquidity
coverage requirements (LCR and NSFR), as well as collateral (including to access
liquidity from the ECB), SBBS tranches would not be eligible for these key purposes.
Thus, unless the regulatory framework is suitably adapted, investors would always rather
prefer to invest directly in the underlying government bonds than in SBBS.
Original Rebased 1/
Austria 58,968 11,666 19.8% 2.0% 2.8% 16.9%
Belgium 118,370 26,683 22.5% 2.5% 3.6% 19.0%
Cyprus 2,428 907 37.4% 0.2% 0.2% 37.2%
Finland 7,936 1,103 13.9% 1.3% 1.8% 12.1%
France 466,817 136,980 29.3% 14.2% 20.5% 8.8%
Germany 331,943 118,091 35.6% 18.0% 26.1% 9.5%
Greece 55,552 12,333 22.2% 2.0% 2.9% 19.3%
Ireland 30,487 15,301 50.2% 1.2% 1.7% 48.5%
Italy 364,109 152,690 41.9% 12.3% 17.8% 24.1%
Latvia 1,565 262 16.7% 0.3% 0.4% 16.3%
Luxembourg 7,961 657 8.3% 0.2% 0.3% 8.0%
Malta 1,845 869 47.1% 0.1% 0.1% 47.0%
Nederlands 161,124 41,199 25.6% 4.0% 5.8% 19.8%
Portugal 43,333 23,039 53.2% 1.7% 2.5% 50.6%
Slovenia 3,335 2,045 61.3% 0.3% 0.5% 60.8%
Spain 374,275 86,451 23.1% 8.8% 12.8% 10.3%
Total 2,030,047 630,274 31% 69.0% 100.0% n.a.
ECB key "home bias"
proxy 2/
Sovereign bonds
(million EUR)
Home sovereign
bonds (million
EUR)
Home sovereign
bonds / total
sovereign bonds
10
This has been confirmed by the many interactions with market participants (both
candidate producers and candidate buyers of SBBS) in consultations conducted in the
context of the HLTF work on SBBS. It is for this reason that the HLTF report concludes
that, "ultimately, the level of investor demand for SBBS and its impact on financial
markets is an empirical question, which can only be tested if an enabling regulation for
the securities is adopted".
Box 4: SBBS versus government bonds in the existing regulatory framework
Under the current regulatory framework, SBBS would be treated as securitised products because
they entail tranching and subordination of credit risk. In regulation, these two elements define a securitised
product, regardless of the underlying composition of the portfolio or its risk.16
As a direct consequence of this fact, SBBS would receive an unfavourable treatment compared with
that of the underlying sovereign bonds along several dimensions, as described below.
Capital requirements
For financial institutions (banks), holding a securitised product rather than the underlying portfolio
gives rise to higher capital requirements. The justification for such non-neutrality in the treatment of
securitisations relative to that of the underlying portfolio comes from model risk (i.e. a higher sensitivity of
the securitisation price to errors in estimating probabilities of default, losses given default, and default
correlation of the underlying assets). Non-neutrality is also justified by agency risk, since securitisation
involves a greater number of parties with potentially conflicting interests (e.g. servicing, counterparty, and
legal risk) than does holding the underlying assets.17
In particular, as per the Capital Requirements Regulation (CRR, Regulation (EU) No
575/2013, Articles 242-270), generally18
there is a floor for the risk weight on securitisation
positions of 7% for banks using the Internal Ratings Based approach (IRB banks) and 20% for
banks using the Standardised Approach (SA banks).
As regards instruments held in the trading book, SBBS would face significant higher
charges for interest rate risk. Sovereign bonds in the trading book are subject to a small capital
charge for interest rate risk. By contrast, securitised products need to be supported by capital of
8% of the amount calculated under the banking book.19
Risk weights to account for general risks
would be, instead, similar for SBBS and sovereign bonds, if the two instruments have the same
duration and market value. In particular, the treatment of specific risk in the Standardised
Approach is similar to the one for credit risk, in practice leading to a zero risk weight for specific
risk.20
SBBS would not qualify as a simple, transparent and standardised securitisation (STS)
under the recently approved STS legislation (Regulation (EU) 2017/2402). The latter explicitly
excludes securitisations of “transferable securities” (such as sovereign bonds) from the products
16
Article 4(61) of the CRR.
17
A third factor in typical securitisation is that the underlying securitised loans are not exposed to market risk
(since they are not tradeable), in contrast with the securitised product.
18
In some cases (see for instance Articles 252 and 260 of the CRR) caps may be allowed that could result in
lower risk weights for SBBS tranches than the floors mentioned here. Similarly, Regulation (EU) 2017/2401,
which comes into force on 1/1/2019, will allow IRB banks that are capable of assessing the risk
characteristics of each individual asset in the underlying pool to apply a maximal capital requirement for
securitisation positions equal to the capital requirements if the underlying exposures had not been securitised.
Depending on the risk weights of the underlying exposures, this could imply a lower risk weight than the
floor, including for non-senior bonds. It needs to be kept in mind that many IRB banks have a risk weight
higher than 0% on their sovereign exposures. Thus, even if the cap is applied, the risk weights for senior
SBBS would not necessarily be 0%.
19
Article 337 of the CRR.
20
Article 336 of the CRR, Table 1 translates a 0% risk weight in the banking book to a 0% risk weight in the
trading book.
11
that may qualify as STSs, since it aims at spurring banks to originate new loans (especially to
SMEs) in support of the real economy, as opposed to repackaging the debt of financial entities or
government bonds. Moreover, for a securitisation to qualify as STS, no single underlying asset
can exceed 1% of the total portfolio. In the case of SBBS constructed in line with the ECB capital
key, this limit would be exceeded by the sovereign bonds of 11 Member States.
For insurance companies, Solvency II provides two ways of calculating the Solvency Capital
Requirement (SCR): an internal model (either full or partial) or the standard formula. The
standard formula defines explicitly which risks are to be taken into account in the SCR
calculation. By contrast, internal models, which are subject to supervisory approval, give
insurance companies a high degree of flexibility. But there is a requirement to take into account
all material quantifiable risks that are in the scope of the model in the determination of the
regulatory capital requirement.
Under the Solvency II standard formula, any securitisation is subject to capital
requirements related to spread risk in the calculation of the SCR. SBBS would therefore be
subject to capital requirements for spread risk and put at a disadvantage relative to direct holdings
of Member State central government bonds denominated and funded in domestic currency (which
would not be subject to such requirements).
A general look-through approach in the standard formula exists under Solvency II for
exposures to investment funds, but not for securitised products. Nevertheless, there is a
“partial look-through” requirement resulting from the fact that securitisations have to be included
in the calculation of the capital requirements for interest rate risk.
Capital rules for pension funds are not fully harmonised at EU level. In particular, applying
capital requirements to securitised products is at the discretion of national legislators.
Liquidity and collateral
While all euro area government bonds qualify as level-1 asset under the EU’s liquidity
coverage ratio (LCR), SBBS would not, by virtue of being considered as securitisation
positions. At present, senior tranches of asset-backed securities can be at best level-2b assets and
subject to a 25% minimum haircut under specific criteria set out in Commission Delegated
Regulation (EU) 2015/61. SBBS would not qualify for this treatment, since sovereign bonds are
not included in the list of eligible underlying exposures.21
The same disparity of treatment
between SBBS and their underlying sovereign bonds occurs as far as the net stable funding ratio
(NSFR) is concerned, as the latter adopts the same definition of liquid assets as the LCR.
SBBS would compare unfavourably to their underlying government bond also in terms of
usability as collateral—a key determinant of financial assets’ liquidity. The Financial
Collateral Directive (Directive 2002/47/EC) makes no distinction between bonds and securitised
products, meaning that it protects them legally in the same way. In practice, market data on the
use of collateral in repurchase transactions suggest that only a small share of them use securitised
assets as collateral (for example, securitised products are not part of any global collateral baskets
of major clearing houses such as Eurex and LCH). In contrast, government bonds are used
heavily as collateral and in securities lending. Utilisation rates are about 50% for German, 30%
for French and 15% for Italian sovereign bonds.22
The extent to which SBBS could be usable as
collateral is likely to be limited under the current regulatory framework, in part because they are
not eligible as collateral in central bank operations23
(the latter is considered a necessary, but not
21
Article 13(2)g of Commission Delegated Regulation EU No 2015/61.
22
Using data from Markit Securities finance, the monetary advantage of being eligible for use as collateral
would be around 15 basis points when euro area average fees for securities lending are taken as a proxy, and
close to 20 basis points for German and French sovereign bonds.
23
Government bonds are presently not foreseen in the list of eligible assets for eligible securitisations in the
ECB’s collateral framework. Moreover, all securitisations presently command by default a 15% minimum
haircut.
12
sufficient, condition for usability as collateral in private repurchase transactions—for example
central securities depositories (CSD) may accept instruments, beyond sovereign bonds or other
publicly guaranteed bonds, if these are eligible at a central bank from which the CSD banking
service provider has access to regular, non-occasional credit).
Investment rules and restrictions
For several types of investors, positions in SBBS may be subject to stricter limits than
positions in sovereign bonds. As a general rule, banks, insurance companies, but also
Alternative Investment Fund Managers (AIFMD) and undertakings for collective investment in
transferable securities (UCITS) can invest in securitised products only if originators retain a
material net economic interest. SBBS would however not be subject to this limitation, because
they can be considered exposures to Member State central governments denominated and funded
in the domestic currency of those central governments.24
However, the following restrictions do
apply:
 UCITS need to respect diversification rules, which may prevent them from holding
large volumes of SBBS. While Member States may authorise UCITS to invest up to 100% in
transferrable securities issued or guaranteed by a public body, this exception may not be
available for SBBS.25
 The Money Market Funds Regulation currently under negotiation26
may restrict money
market funds from investing in SBBS. Although the focus of money market funds on
investments with short maturities suggests they are unlikely to be the main investors in SBBS
across the entire term structure, they could still play a crucial role for the liquidity of SBBS
by accepting them as collateral in private repurchase transactions if this would be allowed.
 Central Counter Parties (CCP) may in principle be able to invest in SBBS under
current rules, if they are considered to be highly liquid. In line with their investment
policies, however, they would probably not be able to invest in junior SBBS since these
securities would be perceived as too risky.
 For insurance companies, the Solvency II framework sets out specific due diligence and
risk management requirements for securitisation positions.27
 For IORPs, Article 19 of Directive (EU) 2016/2341, to be transposed into national law
by 2019, sets out provisions in relation to the prudent person rule, including limits to
excessive risk concentration. Member States may choose not to apply the diversification
requirements to investments in government bonds. Moreover, Member States may impose
quantitative restrictions for securitisations. Article 25 of Directive (EU) 2016/2341
specifically mentions the need for an IORP’s risk management system to address in a
proportionate manner risks which can occur in the area of investments, in particular
derivatives, securitisations and similar commitments, where applicable.
2.2. What are the problem drivers?
The key driver of the problem is that the current regulatory framework of securitisations
does not adequately take into account all the properties of SBBS. This is not surprising,
considering that SBBS are a novel concept that does not yet exist.
24
See, for example, Art. 255 of Commission Delegated Regulation EU No 2015/35.
25
Directive 2009/65/EC (UCITS) imposes diversification on UCITS. Although Art. 54 derogates from Art. 52
and the principle of risk-spreading to allow investments up to 100% in transferable securities issued by the
same entity (i.e. same issuer or same guarantor), SBBS are currently not listed as possible beneficiaries of
this exemption. Moreover, there is a requirement of diversification across different maturities.
26
Commission proposal COM/2013/615.
27
Art. 4(5) and (6) of Commission Delegated Regulation EU No 2015/35 requires insurance companies to
produce their own internal credit assessment for type-2 securitisations. Art. 256 sets out due diligence and
risk management requirements including stress testing for securitisations.
13
In the current regulatory framework, securitisation products attract higher regulatory
charges/discounts than direct investments in the corresponding underlying assets. The
framework, in other words, is not neutral between investing directly in some assets
vis-à-vis investing in structured products backed by these same assets.
The general justification for such non-neutrality comes from securitisation-specific risks,
having to do primarily with sharply asymmetric information between the originator of the
securitisation products and the investors. This asymmetry of information is typically
compounded by the opaque nature of the securitised assets and the complexity of the
structure.
These risks include:
 Agency risk. Originators know substantially more than investors about the assets
composing the securitisation pool. This is obviously the case, e.g., with a bank that
issues mortgages and then securitises them. An investor does not have access to the
same information on the mortgage borrowers as the bank. He/she also can assume
that the bank may have an incentive to securitise first/only the least profitable/more
risky mortgages. It is because of this agency problem that many institutional
investors as well as banks are prevented from investing in securitisations unless the
issuer retains a significant "skin in the game".
 Model risk. As a result of tranching, pay-outs are non-linear (some investors are paid
even if others are not). This generates a higher sensitivity of the price of the
securitised products to errors in estimating probabilities of default, losses given
default, and default correlations of the underlying assets.
 Legal risks. These stem from the fact that there is an additional counterpart involved
(i.e., the arranger of the securitisation) and the complexity of the product (e.g.,
generating uncertainty as to the correct application of the payment waterfall under all
future scenarios).
Yet, SBBS are a sui generis securitisation along several key dimensions:
1. Many of the asymmetries of information and, to an extent, the complexities of the
structure are not present when, as is the case for SBBS, the underlying pool is
composed of euro area central government bonds. These assets are the workhorse of
European financial markets. They are well known and understood by market
participants. Moreover, the structure of the underlying asset pool for SBBS would
basically be predetermined (e.g., in the basic model, the weights of the individual
Member States' central government bonds would be in line with the ECB key).
Hence there is no asymmetry of information between the issuer and the investor.
Indeed, in theory, the issuer/assembler could be a robot.
2. Euro area sovereign bonds are also traded (which means, anyone can get a financial
exposure to them without having to resort to a securitisation) and (for the most part)
liquid (both de facto and, equally importantly, de jure—in the sense that they are
treated as such in regulation).
This means that the securitisation-specific regulatory charges are not justified in the case
of a securitisation of euro-area sovereign bonds (especially one which is assembled
14
followed a pre-defined methodology/recipe, as is the case for the particular SBBS studied
by the ESRB HLTF, and described in Box 1).
Under the current regulatory framework, SBBS face a similar problem as that which has
been addressed with the recent Simple, Transparent and Standardised (STS) regulation.
Specifically, the rationale for the recent STS regulation is that, in the presence of
securitisations which are structured in a particularly simple, transparent and standardised
way, failing to recognise such properties with a specific (and, in practice, more
favourable) regulatory treatment would have hindered their development.
Given the special nature of their underlying assets, namely euro-area central government
bonds, for SBBS the wedge between the regulatory treatment of (traditional)
securitisations and the actual risk/uncertainty of the instrument is even more pronounced
than was the case for STS securitisations. This is for two reasons: (1) the underlying
assets—namely, euro-area sovereign bonds—are even more simple, transparent and
standardised; and (2) euro-area sovereign bonds receive the most favourable regulatory
treatment in light of their properties and functions in the financial sector.
In addition, investment decisions as regards government bonds are particularly sensitive
to costs and fees (again, because of the volumes involved, the competition, their being in
effect "benchmarks", etc.). Relevant costs, from the viewpoint of a financial institution,
do include the cost of capital associated with the purchase of such assets. This means that
failure to address this regulatory issue is likely to have a correspondingly greater
impeding effect on the developments of the market for SBBS than would have, for
example, been the case for STS securitisations.
Box 5: Why is regulatory non-neutrality a problem only for SBBS?
Despite facing higher regulatory charges (in the form, e.g., of surcharges in the calculation of
capital requirements for banks/insurance companies, or limited/reduced usability of structured
products as collateral) than investing directly in the underlying asset pool, market participants
typically do engage in assembling, marketing and investing in (traditional) securitisations, such
as Mortgage-Backed Securities (MBS).
This is because traditional securitisations create value by not only redistributing the credit risk of
the underlying pool, but also by creating liquidity. Through traditional securitisation, a set of
assets which are typically individually non-tradeable, opaque, and risky, can be repackaged in
tranches with different economic features. In particular, the senior tranche, by virtue of the
combined support from diversification of the underlying portfolio (which can reduce, and in the
limit, eliminate diversifiable risks) and the existence of a sub-senior tranche acting as first-loss
absorber, can become a highly-rated, tradeable and liquid asset. Thus, through securitisation,
even an investor who is restricted – by either the law or its individual investment
mandate/charter – to invest only in liquid and highly-rated assets can gain exposure to projects
(e.g., mortgages) which individually would not have had these required properties. Hence this
investor may be willing to incur the regulatory charges associated with a securitisation tranche if
he/she values high ratings and liquidity sufficiently. Moreover, and importantly, for some
underlying assets (in particular, non-traded mortgages or loans issued by a bank), an investor may
simply have no other way of securing an exposure than indirectly by buying a stake in the
structured product backed by such assets.
These supporting considerations do not apply to SBBS securitisations, given their sui generis
nature. In particular, since the underlying assets, i.e. euro area central government bonds, are
individually tradeable and liquid, there is no need to resort to a securitisation to gain exposure to
such instruments, nor can one, by doing so, gain in terms of, say, liquidity – indeed, if anything,
15
it is quite likely that until and unless an SBBS market of sufficient size develops, each individual
underlying bond would be more liquid than any of the SBBS tranches.
In sum, securitisation in the case of SBBS only serves as a tool to concentrate the risk of the
underlying sovereign portfolio in one instrument (the junior tranche), and relieve of it from
another (the senior tranche). But there is not much scope for improving on the ratings of the
safest of the underlying assets, nor to create liquidity. Thus, unless SBBS securitisations are
granted the same treatment as their underlying sovereign bonds, they will not be produced or
demanded by the private sector.
2.3. How will the problem evolve?
In the baseline (with no intervention) the regulatory hindrances deriving from the gap
between the regulatory treatment of SBBS and that of their underlying sovereign bonds
may diminish somewhat over time, in particular for banks, but are unlikely to disappear
altogether.
In particular, the recent revision of the CRR (Regulation (EU) 2017/2401), which is
expected to come into effect in 2019, could result in reduced regulatory surcharges faced
by SBBS vis-à-vis government bonds in terms of Pillar-1 capital requirements.
Specifically, under certain conditions (see footnote 18), senior tranches may be able to
benefit from a zero risk weight after application of the "look-through" principle, which
will be possible not just for banks sponsoring/originating securitisations – as is currently
the case – but also for banks investing in them. Non-neutrality for Pillar-1 capital
requirement purposes would be established also for sub-senior tranches for the subset of
banks using Internal-Ratings Based models (IRBA-banks), but not for others.28
Nevertheless, important sources of unfavourable regulatory treatment – most notably in
terms of liquidity-related regulation – would remain, including for the senior SBBS.
The HLTF report points out that, if RTSE were to be reformed and, for example, capital
charges for banks' sovereign exposures were to be introduced and made sensitive to
concentration or credit risk, senior SBBS may become more attractive, compared to their
underlying sovereign bonds, for banks by virtue of SBBS' greater diversification/safety.
This might offset some of the regulatory hindrances associated with "undue"
securitisation-related additional regulatory charges. At the same time, the report notes
that this finding does not pertain to the overall merits or demerits of RTSE reform.
Therefore, for the baseline, we assume no RTSE change would take place. This is also in
line with the conclusion of the discussions at international level (in the Basel Committee
on Banking Supervision).29
Any reform of RTSE would have profound implications in
terms of financial stability. Thus the European Commission has clearly stated that it
considers that a reform of the prudential treatment of sovereign exposures can only
happen after several pre-conditions are in place, including a full Banking Union and
substantial progress towards a Capital Markets Union and the existence of a European
28
See section 2, Annex 4 for some quantitative indication of the extent of the problem even after the entry into
force of the new securitisation framework per regulation (EU) 2017/2401, expected for 1/1/19.
29
The issues discussed are summarised by the Basel Committee in the December 2017 Discussion Paper on "The
regulatory treatment of sovereign exposures" available at https://www.bis.org/bcbs/publ/d425.htm. In
presenting it, the Committee notes that it "has not reached a consensus to make any changes to the treatment
of sovereign exposures, and has therefore decided not to consult on the ideas presented in this paper."
16
safe asset. In addition, if a level playing field for Europe’s financial sector is desired, an
agreement at the global level would also be essential.
A European safe asset, a new financial instrument for the common issuance of debt, is a
necessary step in the completion of the EMU architecture (European Commission, 2017).
It would need to be sizeable enough to become the benchmark for European financial
markets, and create a large, homogenous and liquid EA-level bond market, avoiding
sudden stops and financial fragmentation, and increasing the total European and global
supply of safe assets. The Commission will further reflect on different options for a safe
asset for the euro area in order to encourage a discussion on the possible design of such
an asset, separately from the present discussion on the introduction of an enabling
framework for SBBS.
As regards insurance companies and other asset managers, no changes are expected in
the baseline as regards the regulatory disincentives/limits to hold SBBS as opposed to the
underlying sovereign bonds.
In a nutshell, Figure 4 summarises the elements of the "problem tree" (i.e., problem,
driver, and consequences), as described in section 2.
Figure 4: The Problem Tree
3. WHY SHOULD THE EU ACT?
3.1. Legal basis
SBBS are a tool to enhance financial stability and risk sharing across the euro area. They
can thus contribute to the better functioning of the internal market. Article 114 TFEU,
that confers to the European institutions the competence to lay down appropriate
provisions that have as their objective the establishment and functioning of the internal
market, is thus the appropriate legal basis.
Drivers
•D1. The current
regulatory framework
does not adequately
capture all the
properties of SBBS
Problems
•P1. SBBS face "extra"
regulatory charges and
discounts when
compared to their
underlying sovereign
bonds
Consequences
•C1. There are
unwarranted
disincentives for the
private sector to
assemble, sell and/or
invest in SBBS
•C2 No sizeable market
for SBBS can emerge
17
3.2. Subsidiarity (Necessity of EU action)
Identified regulatory impediments to the development of SBBS markets are laid down in
several pieces of EU legislation (e.g. Regulation (EU) 575/2013 (CRR) on the prudential
treatment of credit risk or market risk for banks; Delegated Regulation (EU) 2015/35
(Solvency II) on spread risk on securitisation positions for insurance companies; or
Directive 2009/65/EC (UCITS), on eligibility criteria, concentration limits and
diversification requirements for UCITS). As a consequence, on a point of law, individual
Member State action would not be able to achieve the goals of this legislative initiative,
i.e. to remove such regulatory impediments, since amendments of EU legislation can
only be done through EU action.
But even aside from this legal consideration, action at the Member States' level would be
suboptimal. It could result in different instruments being "enabled" in different Member
States. This would render the market rather opaque and split market demand in various
different instruments, which would make it difficult (or even impossible) for any one of
them to acquire the requisite standing in terms of size and liquidity. Furthermore, even if
national legislators would address the same instruments by steps to remedy the currently
disadvantageous regulatory treatment, a race between national legislation could emerge
to offer as favourable as possible regulatory treatment. Furthermore, in both cases, i.e.
addressing differently defined products or giving different regulatory treatment, such
different national legislations would create de facto obstacles to the Single Market
(e.g., high compliance costs for an arranger that would want to operate in multiple
jurisdictions). For all these reasons, action at the EU level is necessary and appropriate.
These obstacles would have sizeable effects, given the very high integration of the
underlying government bond markets and the identical regulatory treatment of these
across the EU.
3.3. Subsidiarity (Value added of EU action)
Establishing an appropriate regulatory framework for this novel product, which—as
mentioned above, can only be done via action at the EU level—has value added insofar
as it may enable the development of an additional market through which financial risks
can be better shared, thus promoting financial stability as well as lower overall borrowing
costs for sovereigns and private sector agents.
4. OBJECTIVES: WHAT IS TO BE ACHIEVED?
4.1. General objectives
The general objective is to remove identified regulatory impediments against a (privately
produced, not mutualised) liquid, low-risk asset, such as the (senior) SBBS. Such an
asset could facilitate private sector risk sharing—especially across borders—and risk
reduction. This would strengthen the Banking Union.
In particular, as summarised in Box 1 and discussed at greater length in Brunnemeier et
al (2016b), ESRB HLTF (2018a) and ESRB HLTF (2018b), a pan-euro area low-risk
asset such as the senior SBBS could facilitate the diversification of euro area banks'
sovereign portfolios. This would reduce the extent of "home bias" in banks' balance
18
sheets, which despite recent progress remains rather high in some Member States. This,
in turn, would foster stability in the euro area: it would weaken the nexus between banks
and their sovereign and it would spread perceived idiosyncratic sovereign risk more
widely across borders within EMU.
A low-risk asset like the (senior) SBBS could also help avoid that exogenous capital
flows in search of "safety" affect the cross-section of euro area funding costs in an overly
unequal manner, as in practice is the case at present since only sovereign bonds of a few
Member States are at present perceived to be very low risk. It could also help address the
increasing relative scarcity of euro-denominated low-risk/high-rated assets resulting from
increasing demand for such assets—also due to regulatory requirements on financial
institutions (e.g. Liquidity Coverage ratio (LCR), Net Stable Funding Ratio (NFSR),
etc.)—against a background in which the assessed creditworthiness of several EU and
euro area Member States has deteriorated in the wake of the global financial crisis.
Importantly, such an asset is meant to be solely based on private-sector initiatives,
without the possible support of any (perception of) mutualisation of risks and/or losses
among EU Member States. This is a key desideratum, and will need to be kept in mind in
determining the specific content of any proposed initiatives.
4.2. Specific objectives
For an asset like the SBBS to be "enabled", the following two objectives would have to
be achieved:
1. Eliminate undue regulatory hindrances (i.e., restore regulatory "neutrality" for SBBS
securitisations).
2. Encourage liquidity and "benchmark" quality (i.e., the new instrument should be
treated like other benchmarks in regulation—de jure liquidity—and should be
capable of attaining a sufficient critical mass/standardisation so as to be liquid also
de facto).
Importantly, removing undue regulatory hindrances, by assuring that the product is
treated as its underlying government bonds, is only a necessary condition for the
development of such markets, but does not guarantee it—after all, SBBS are meant to be
developed by the private sector. The actual development of such a market, after the
removal of identified regulatory hindrances, will rather depend on the economic viability
of the product, i.e. on whether it will be advantageous for investors to acquire them and
private arrangers to issue them—this in turn depends on the extent to which the new
products would become "benchmarks" and easily traded, among other considerations
(e.g., the strength of the demand for sub-senior tranches, etc.). The HLTF report has
extensively analysed the issue and concluded that ultimately only a "market test" would
be able to settle remaining doubts as to the viability of SBBS. The specific objective of
the proposed regulatory framework is indeed to enable such a market test. In contrast, the
regulation will not, as discussed further in Section 5.3 below, provide incentives to the
development of SBBS markets, besides—that is—removing identified regulatory
obstacles.
19
5. WHAT ARE THE AVAILABLE POLICY OPTIONS?
Given the problem definition above, the first policy choice to be made is between keeping
the status quo (i.e. "do nothing", or baseline) versus introducing a legislative proposal to
enable the development of SBBS market ("an enabling framework for the development of
SBBS," in the language of President Juncker's September 2017 Letter of Intent).
If it is found opportune to introduce such a legislative proposal, two main policy choices
would need to be made, namely on the scope of applicability of the proposed legislation
and on the extent to which the legislation should enable the various tranches. Given this,
five main "models" for the proposed legislation are seen as deserving in-depth
consideration (see Figure 5). Separately, a third key policy choice has to be made as to
how to ensure compliance with the proposed new legislation itself. Here three options
are assessed, i.e. self-certification on its own, or complemented, respectively, with a third
party assessment or ex-ante supervisory approval.30
5.1. What is the baseline from which options are assessed?
The baseline is the status quo, i.e. no legislative intervention and unchanged RTSE (see
earlier discussion on page 15). In this scenario, SBBS are likely to remain an interesting
theoretical construct, but would not be produced and made available to investors. This is
because they would face significant additional regulatory charges (e.g., in terms of
required capital), discounts (e.g., in terms of eligibility for liquidity requirements), and
limits (in terms of investability for some market players) as compared with their
underlying sovereign bonds, which will render them unappealing or prohibitively
expensive.
To gauge the extent of regulatory hindrance faced by SBBS in the baseline, the HLTF
report shows that, if the banks covered by the EBA 2015 Transparency Exercise were to
switch all their current holdings of euro-area sovereign bonds into senior SBBS tranches
today (so without an "enabling" regulatory framework in place), they would face an
increase in aggregate capital requirements in the order of EUR 70 billion (see Annex 4,
Section 1). Of course, this is just a gauge, and less extensive switches would result in
correspondingly lower capital requirements. At the same time, if banks also bought sub-
senior tranches, which currently would face much higher risk weights than senior ones,
the capital requirement implications could also be much larger.
These hurdles are likely to remain even after taking into account some regulatory
changes which are already in the pipeline, e.g. those stemming from the recent revision
of the securitisation framework (Regulation (EU) 2017/2401), due to become effective
on 1/1/2019. Regulation (EU) 2017/2401 foresees reduced capital requirements on
securitisation positions for banks provided they are at all moments perfectly informed
about the composition and risk features of the underlying assets—this condition is likely
to be easily satisfied for SBBS (especially if the latter have a narrowly defined
"recipe"—see below). Nevertheless, the subset of banks using the Standardised Approach
30
The problem of how to ensure compliance with a legislation that dictates a specific treatment for a subset of
securitisations has already been addressed in the context of the regulation on Simple, Standard, and
Transparent securitisations (STS). Thus a similar approach will be used here.
20
(henceforth, "SA banks") would still face large capital requirements when holding
sub-senior tranches under the baseline after 1/1/2019. Section 2 of Annex 4 shows that,
for each EUR 100 billion of investment in SBBS, assuming SA banks purchase the three
tranches in a balanced manner and in line with their current share of sovereign bonds in
the banking book, aggregate risk-weighted assets would increase by some
EUR 87 billion (this number would need to be multiplied by a capital requirement ratio,
typically in the range of 8-13 percent, to arrive at the implications of the investment in
SBBS for capital requirements).
Against this baseline, the alternative option is to intervene by proposing an "enabling"
regulatory framework that adequately reflects the unique nature of securitisations issued
against a portfolio of euro area sovereign bonds. This option can take different
declinations, depending on the desired extent to which SBBS are equated—in terms of
regulatory treatment31
—to their underlying components (i.e. euro-area sovereign bonds)
and on how precisely one goes about designing any such desired regulatory treatment in
practice.
In his Letter of Intent accompanying his September 2017 State of the Union Address to
the European Parliament, President Juncker has committed the European Commission to
introduce an "enabling framework" for SBBS, in other words to move past the baseline
of no intervention.
This course of action is dictated by the potential benefits associated with the concept of
SBBS. Although whether or not SBBS, once freed of existing regulatory impediments,
will actually take off is difficult to predict, the fact remains that the benefits, in expected
terms (i.e., weighted by the probability of them actually materialising), that would stem
from the development of a market for SBBS far outweigh the cost of introducing the
enabling framework.
Aside from the one-off direct costs of introducing the product regulation (which, it bears
recalling, in effect recalibrates existing regulations to allow for a completely new
product), other possible costs would stem from "unintended consequences" of a
developed SBBS market. Importantly, when assessing such possible costs and risks, one
has to distinguish between those which result (or are intensified) directly by the existence
of SBBS in financial markets, from those that would happen as a reflection of
developments in the fundamentals of the underlying sovereign bonds, which would likely
affect SBBSs but that would occur regardless of whether SBBS are in the market or not.
For the latter set of costs/risks, the relevant yardstick of comparison is whether the
presence of SBBS aggravates them or not.
In the former category (i.e., risks stemming directly from the development of SBBS
markets), the key one considered both by the HLTF and for this impact assessment has to
do with the possibility (flagged, in particular, by euro-area Debt Management Offices)
that packaging a lot of a given government's bonds into SBBS could adversely affect the
31
Note that extending the regulatory treatment of euro-area sovereign bonds to any given SBBS tranche would
be tantamount to addressing, for that specific tranche, all dimensions of currently differential treatment as
described in Box 4.
21
liquidity of the bonds of said government that remain outside of the SBBS construct. The
HLTF has analysed at length the likely effects of SBBS on the liquidity of national
sovereign debt markets and it has concluded that, certainly for moderately-sized volumes
of SBBS, these are likely to be limited (see, in particular, Volume II, section 4.4 of the
ESRB HLTF report and Annex 4.3 of this impact assessment).
In the latter category (i.e., risks that stem from possible developments in the
fundamentals of underlying sovereign bonds, e.g. causing the loss of the AAA rating for
the senior SBBS tranche), the key question is whether, in a crisis circumstance, the
presence of SBBS is stabilising or destabilising. Note that it is quite possible that, during
an episode of turbulence linked to marked deterioration in the creditworthiness of one or
more euro area sovereigns, it may become difficult or even impossible to assemble
SBBS, presumably because there will be no demand for the junior tranche in those
circumstances. (In extreme circumstances, the senior tranche might also be downgraded).
But this would still leave those sovereigns who do remain creditworthy able to issue their
own bonds, while for the others the problem would not be different than if SBBS had
never been created. Even if volume of SBBS (temporarily) stops growing in such a
circumstance, the stock of already issued SBBS may still prove helpful in channelling
financial flows from across national borders (as happens at present, with investors fleeing
Member States in trouble and seeking safe haven in "core" Member States) to a
"cross-instrument" pattern (i.e., from the junior to the senior tranches). This would be
less damaging to the integrity of the euro area. Moreover, bonds packaged in the already
issued SBBS would not be "available for sale", which would in itself provide some
stabilisation ("fire sale"-driven spikes in individual Member States' funding costs would
be avoided).
Others have argued against an enabling regulatory framework on the ground that the
product is not viable. For instance, no private issuer may deem SBBS to be sufficiently
profitable, or there may not be sufficient demand for the junior tranche. In our view, this
is no grounds not to rectify the identified regulatory "failure". Rather, it would just
indicate that the above-mentioned "market test" would not have (yet) been successful.32
On the basis of the above arguments, this assessment concludes that the Commission has
no option but to propose an "enabling framework" and that indeed doing so generates, in
expected terms, a net social gain. Section 5.2 describes the intervention options
considered, while section 5.3 describes options which have been discarded after careful
consideration.
32
Once regulatory impediments have been eliminated, demand (and thus the development of the SBBS market)
could still take place in the future if, say, the overall euro-area/global macroeconomic environment turns
more supportive.
22
5.2. Description of the policy options
Option Description
1. Scope of applicability of the proposed legislation
1.1 Only SBBS proper Only securitisations of euro-area sovereign bonds that comply
with the SBBS recipe (see Box 6), i.e. whereby the underlying
portfolio comprises all euro-area sovereign bonds with respective
weights in line with the ECB capital key (rebased, as necessary, to
exclude Member States that either have no or too little
outstanding debt or might have lost market access) and which
have tranching levels such that the senior tranche is "low-risk"
(e.g., the senior tranche is not greater than 70%)33
.
1.2 All securitisations of
euro-area sovereign
bonds
Any securitisation of euro-area sovereign bonds, regardless of the
composition of the underlying portfolio and/or the number and
levels of tranches, would be eligible for the regulatory treatment
envisaged in the proposed product legislation.
1.3 A basket of euro-area
sovereign bonds (no
tranching)
Claims on an investment fund which invests fully in a basket of
euro-area sovereign bonds, with respective weights in line with
the ECB capital key (rebased, as necessary, to exclude Member
States that have no outstanding debt and those who have lost
market access), without tranching.
2. Extent of "restored" regulatory neutrality
2.1 Extend the regulatory
treatment of euro-
area sovereign bonds
to all tranches
All tranches of the products eligible for the proposed legislation
would be given a treatment comparable to that of euro-area
sovereign bonds (in particular, no capital requirements, level-1
eligibility for LCR/NFSR purposes, no concentration
charges/limits, no investment restrictions.
2.2 Extend the regulatory
treatment of euro-
area sovereign bonds
only to senior
tranches
Only the senior tranche of the products eligible for the proposed
legislation would be given a treatment comparable to that of euro-
area sovereign bonds (in particular, no capital requirements, level-
1 eligibility for LCR/NFSR purposes, no concentration
charges/limits; no investment restrictions). Sub-senior tranches
would, instead, have additional charges, liquidity discounts,
concentration charges, and investment limits.
3. Compliance mechanism
3.1 Introduce a self-
attestation
mechanism
Responsibility for compliance with the criteria envisaged in the
legislation will lie with the originator of the securitisation.
3.2 3.1 + third-party
assessment
Self-attestation by the originator, complemented by assessment
provided by an independent third party.
3.3 3.1 + ex-ante
supervisory approval
Self-attestation by the originator, complemented by ex-ante
supervisory approval.
33
See footnote 9 for an explanation of how the 70% threshold is arrived at in the HLTF report.
23
5.3. Options discarded at an early stage
Regulatory incentives
In addition to the options set out above and discussed in more detail below, a related but
different one has been considered, namely going beyond the mere levelling of the
regulatory playing field for SBBS by providing them the same treatment as for sovereign
bonds, to actually providing them a preferential regulatory treatment (i.e., outright
regulatory incentives).
The main advantage of such approach is that the demand for SBBS would be
correspondingly boosted and the potential benefits of SBBS would materialise faster and
at a larger scale.
There are two main drawbacks, however. First, using the regulatory framework to the
advantage of this new product could, at least in a transition phase, destabilise (some)
national debt markets, as demand for SBBS might replace, rather than complement,
demand for stand-alone national sovereign bonds. Second, regulatory incentives could be
seen as a signal that the Commission, and more generally the European authorities, stand
ready to bail out investors, should these novel structured products encounter problems.
Such expectations would be highly detrimental, as they could lead to moral hazard on the
part of Member States and of investors.
On the basis of the above considerations, such an option has been discarded. The
proposed legislation would aim at treating SBBS as much as possible as euro-area
sovereign bonds (i.e., restore "regulatory neutrality"), but not better/more favourably.
Public issuance
A second option, discarded after careful consideration, is that of a public issuer/arranger
for SBBS (this could be either an existing institution, such as the ESM, or a newly
created public SPV). A public arranger could benefit from economies of scale (which
would ease the viability test for SBBS) and may meet greater confidence from market
participants from the very start. However, entrusting a public authority with such task
would shift a well-established private-sector activity to the public sector. This might also
mean that the possible link and synergies of such activity with that of (private-sector)
market-making of government bonds could not be reaped.
Furthermore, deploying a public issuer could also result in some mutualisation of risks
(for example, in terms of warehouse risk for any period between the assembling of the
SBBS portfolio and the selling of all the tranches), which could result in moral hazard
(this concern has been raised by several observers/stakeholders, including Debt
Management Officers—see Annex 2). Also, a public arranger would need some funds
(for example a one-time fixed endowment of a limited quantity of paid-in capital) for the
purpose of assembling SBBS cover pools. Providing a public arranger with any public
funding or support may increase the risk that market participants misperceive such
activity as providing an implicit guarantee for SBBS payment flows.
24
On the basis of the above considerations, such an option has been discarded. The
proposed legislation would aim at removing the impediments for private sector
production/use of SBBS. Once again, it bears reminding that removing the identified
regulatory impediments enables the development of this novel private financial
instrument, but in no way guarantees it. It may well be the case that, quite aside from the
regulatory framework, assembling SBBS will prove too costly/insufficiently
remunerating for the private sector. The viability of SBBS might also be a function of the
more general economic backdrop, e.g., the level of interest rates and/or expected fiscal
and real developments.
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS?
6.1. Scenarios and benchmarks of benefits and costs
6.1.1. Scenarios
To cater for a wide range of possibilities, the impact of different intervention options has
been assessed under two different scenarios: a limited volume scenario, whereby SBBS
reach an overall volume of EUR 100 billion, and a steady state scenario whereby SBBS
reach an overall volume of EUR 1,500 billion.34
The final scale of the SBBS market will
depend on the instruments' overall attractiveness for the market, given that the legislative
intervention is only a necessary but not necessarily sufficient condition for SBBS's
development.
6.1.2. Benchmarks of benefits and costs
As regards the choices with respect to the scope of applicability of the proposed
legislation (section 6.2 below) and the extent to which the regulatory treatment afforded
to euro area sovereign bonds (henceforth, "benchmark" regulatory treatment) is also
provided to the various SBBS tranches (section 6.3 below), the following benefits and
costs have been assessed:
- reduction in capital requirements (benefit);
- reduction in liquidity of national sovereign debt markets (cost);
- impact on volume of sovereign bonds rated AAA (benefit/cost);
- reduction in holdings of domestic sovereign bonds (benefit);
- impact on share of sovereign bonds rated AAA in banks' balance sheets
(benefit/cost);
- facilitating cross-border integration and the reduction of asymmetric shocks
(benefits).
The benchmarks used are the evolution in % compared to the baseline scenario (current
situation), or the amount of regulatory hindrance faced in the baseline (no intervention)
by SBBS instruments, except for the liquidity of national debt markets as well as the last
34
Both scenarios are considered in the HLTF report. In particular, as regards the steady state scenario, the HLTF
considers an amount of EUR 1,500 billion as indicative of the size that an SBBS market could achieve while
maintaining an adequate secondary market free float in national sovereign bond markets.
25
criteria (integration of capital flows cross-border), where the analysis remains mainly
qualitative.
For the third key choice, i.e., the certification model (section 6.4 below), the main benefit
to be assessed is the increased investor confidence while costs include both the potential
moral hazard and the administrative burden for stakeholders. The assessment remains
mainly qualitative for that option.
6.2. Scope of applicability of the proposed legislation
This section describes and assesses the scope of applicability of the product legislation,
i.e. the range of sovereign bond-backed securities to which the legislation would apply.
The two polar options are, thus, applying the proposed product legislation to any
securitisation of sovereign bonds, or only to a particular combination of sovereign bonds
(whether tranched or in a "simple" basket).
6.2.1. Option 1.1: only SBBS proper
Option 1.1 deals with one extreme, where the legislation would be made applicable only
to SBBS proper, i.e. securitisations of euro area sovereign bonds which meet the official
"SBBS recipe".
Box 6: The SBBS structure
A set SBBS structure (i.e., a methodology to assemble SBBS), e.g. a fixed portfolio of euro area
sovereign bonds with known weights (e.g., in line with the ECB capital key—see Box 1) and
specified tranching points, is helpful to create a standardised product, which in turn enhances the
product's appeal (e.g., in terms of liquidity).
However, there may be circumstances in which some changes in this set structure are warranted.
For example, an EU Member State may join the euro area. Or a Member State issues too little
debt, so that it becomes difficult if not altogether impossible for arrangers to acquire the
necessary amount of bonds of that Member State as prescribed by the current structure. Or it may
be necessary (respectively, possible) to reduce (resp., increase) the size of the senior tranche if
the ratings of the underlying euro area sovereign bonds deteriorate (resp., improve).
For such exceptional cases the regulatory framework should foresee safeguards, which allow for
controlled and limited modifications of the set SBBS structure. The trade-off is between adapting
the product to the changed reality and safeguarding standardisation. Efficiency will likely call for
minimizing the changes to the set structure as much as possible.
Who would set the SBBS structure and through what procedure would it be changed?
There are in principle three avenues:
1. A public agency (e.g., ESMA) could be tasked, in the enabling regulation, to spell out the
initial SBBS recipe and to propose adjustments to it when necessary. These proposals would
be akin to regulatory technical standards, which are approved by the Commission.
2. The Commission itself could define and adapt the official SBBS recipe by way of
Implementing Decisions.
3. Alternatively, a private entity (e.g., a consortium of arrangers) could set out, and change as
appropriate, the "standard" for the SBBS product.
These avenues will be explored in the drafting of the legislative proposal, with a view to
maximize the likely chance of success of the product (including by underpinning market
confidence and legal certainty, e.g. with respect to its eligibility for the proposed regulatory
treatment) and minimize administrative burden.
26
Should the product legislation apply only to SBBS proper, thanks to the ensuing induced
standardisation, a sizeable market for this particular instrument is likely, although by no
means certain, to develop. This, in turn, could enhance liquidity and appeal of the new
instrument, and provide greater incentives for banks and other financial institutions to
invest in them. This prospect in itself may be an important factor in generating sufficient
demand. So, a narrower scope of applicability of the proposed legislation may be
’enabling’ in and of itself, as far as the ultimate development of SBBS is concerned (see
responses to the public survey on liquidity and standardisation in Annex 2, section 1).
One critical feature of the SBBS proper is the tranching of the instrument which should
ensure that the senior tranche is granted a AAA rating (note that this may require
adjusting the size of the tranche over time in response to future economic, financial and
political developments – see Box 6). Assuming the senior tranche at a 70% tranching
point is granted a AAA-rating (i.e., is considered as safe as the safest assets in
circulation), the Commission's analysis (see section 4 in Annex 4) shows that the
introduction of the SBBS could increase the volume of AAA sovereign bonds available
in the euro area by some 2% (in the limited volume scenario) and up to 30% (in the
steady state scenario) compared to the baseline with no legislative initiative and thus no
SBBS.
Under this option, the impact on the diversification of banks' sovereign portfolios would
range from a reduction by 3% of domestic sovereign holdings to a reduction of those
holdings by 34%, depending on the scenario (limited volume vs steady state scenario).
Similarly, the share of government bonds rated AAA on banks' balance sheets would
increase by about 40% under the steady state scenario (from 24% to 32% or 33%
depending on the regulatory treatment), but remain roughly unchanged under the limited
volume scenario (see section 4, Annex 4).
A key concern raised by several stakeholders is that SBBS might adversely impact the
liquidity of national sovereign debt markets. These concerns are the more relevant the
smaller the national sovereign bond market (this is, e.g., in particular the case for small
Member States) and the larger the overall volume of SBBS. Given the importance of
such concerns, the HLTF has conducted an in-depth analysis, which is summarised in
Section 3, Annex 4. The main conclusion is that the ultimate impact on the liquidity of
the national sovereign bond market results from two opposing channels: On the one
hand, as the size of SBBS market increases, the liquidity for the remaining national
bonds outside the SBBS scheme could suffer because of the reduction in the residual
outstanding float. On the margin, this could lead to higher funding costs for the most
affected Member States and a hampered price discovery process.35
On the other hand,
SBBS might attract additional demand for national sovereign bonds, and thereby add to
their liquidity (this is especially true for those sovereigns that are not typically in the
radar screen of large global investors—which is also often the case for smaller Member
States). SBBS portfolios would also support prices, and thus be liquidity-enhancing—as
bonds included therein could not be sold abruptly in episodes of turbulence.
35
For this reason, as has been done for example for the ECB's Public Sector Purchase Program, caps could be
envisaged on the share of outstanding sovereign bonds of individual Member States that can be used for
SBBS.
27
The impact of option 1.1 on different stakeholders depends on different factors, such as
the regulatory treatment of the SBBS tranches (see options 2.1 and 2.2) and the market
size SBBS would ultimately achieve. Annex 3, Table 7 and Table 8 give some overview
of expected impacts compared to the benchmark scenario (in particular for models 1
and 2). For banks, other investors and arrangers the impact is expected to be (very)
positive given the availability of a new standardised and profitable product. For
supervisors, administrative expenses will depend on the model chosen for ensuring and
monitoring compliance (see section 6.4). They may be larger if a certification of each
issuance is required compared to the self-certification option. But in any case these
expenses are likely to remain small (since all that would be required would be monitoring
compliance of the underlying portfolio with the ECB capital key and that the tranching
levels are appropriate) and to be outweighed by the enhanced stability of the financial
system from greater diversification in banks' sovereign portfolios and weakened bank-
sovereign nexus. As discussed above, some national sovereign bond markets could be
adversely affected in terms of residual floating stock of debt, but these effects would
materialise only if SBBS reach a truly large scale and could in any case be
counterbalanced by the increased demand for such bonds.
Neither option 1.1, nor any of the other options discussed below, is expected to impact
directly on retail investors, households or SMEs, because they would unlikely be active
in SBBS markets. At the same time, these sectors would benefit indirectly—including
from enhanced confidence—to the extent that the above-mentioned macroeconomic and
financial-stability benefits materialise.
Neither option 1.1, nor any of the other options discussed below, is expected to have a
direct social impact, environmental impact or impact on fundamental rights.
6.2.2. Option 1.2: All securitisations of euro area sovereign bonds
Option 1.2 envisages that the legislation is made applicable to any securitisation of
sovereign bonds, or at least of those sovereign bonds that are actively traded. After all,
the economic considerations as to why otherwise such securitisations would stand no
chance of being produced and demanded have a rather general applicability.36
This option would thus provide the widest possible scope of applicability of the
legislation, and would also maximize the scope and flexibility for economic agents to
take advantage of securitisation techniques to better share and allocate euro-area
sovereign risk. It may also simplify the necessary market infrastructure, e.g., in terms of
ascertaining/certifying eligibility of any candidate securitisation for the product
legislation, thus minimising administrative and other costs (more on this in section 6.4
below).
The disadvantage of Option 1.2 would be that it is unlikely that any given securitisation
of sovereign bonds, among the infinite possible varieties, would become prominent or
established in the market, and thus gain the role and carry out the functions of a liquid
benchmark security. Yet, liquidity is clearly an essential feature for any security to be
36
At present, EU banks can, for example, apply zero risk weights to their holdings of any and all EU sovereign
bonds denominated in the sovereign's own currency.
28
appealing for investors to hold, in particular for securities which are closely related to
sovereign bonds—the benchmark "safe assets" par excellence for investors (see Annex 2,
in particular the responses to the public survey on liquidity in section 1, the summary of
the Industry Workshop in section 2, and the summary of the dedicated DMO workshop
in section 3). Unless these new securitisation products acquire sufficient liquidity, it
would for example be unlikely that banks would hold them in lieu of their current (liquid,
but often too concentrated) holdings of sovereign bonds.37
For the same reason, the extent to which this option would generate a product with net
benefits accruing uniformly across euro-area Member States is unclear. It would depend
on the products that would actually be launched in the market and on which ones (if any)
become more commonly used over time.
The impact of option 1.2 on the volume of AAA assets and on the composition of
sovereign portfolios on banks' balance sheets would greatly depend on the structure of
the products issued and purchased by banks. However the expected lack of liquidity for
those products probably prevents their wide dispersion, so that the related impacts
(compared to the baseline scenario) are expected to be small.
The impact of option 1.2 on different stakeholders depends on different factors, such as
the regulatory treatment of the various tranches (see options 2.1 and 2.2) and the market
size they would ultimately achieve. Overall, the impact on banks and other investors may
be positive or neutral, as new products become available, although their attractiveness is
questionable given their lack of standardisation and ensuing likely lack of liquidity. The
impact on arrangers is expected to be positive or neutral, depending on the profitability of
the product and the market size. For supervisors, the impact crucially depends on the
market structure and is difficult to predict ex-ante. As regards the impact on national
sovereign bond markets, the impact depends mainly on the size/attractiveness of these
new products. The bigger their market, the more they become a competing product for
sovereign bonds and may affect sovereign bond market liquidity. At the same time,
funding costs could be positively affected though reduced bank-sovereign nexus risks.
See Annex 3 (in particular models 3 and 4) for further details.
6.2.3. Option 1.3: A basket of euro-are sovereign bonds (with weights
according to the official "SBBS recipe")
Option 1.3 concerns making the legislation applicable to a specific portfolio of sovereign
bonds, i.e. one whose individual weights are in line with the official "SBBS recipe" as
presented in Box 6 (so this portfolio would be the same as that used for SBBS, but
without tranching). In what follows, such a product will be referred to as the "basket".
Restricting the applicability of the proposed legislation only to this basket, as opposed to
any basket, is in the interest of facilitating, through standardisation, the emergence of a
benchmark liquid asset.
Functionally, this basket would be equivalent to a securitisation with a single tranche.
However, from a regulatory point of view it is not a securitisation, as there is no
37
Therefore providing such a wide range of securities with benchmark treatment in terms of regulatory liquidity
may well be unwarranted.
29
tranching element when constructing the product, which is one of the two defining
features of securitisation. The other defining feature is the pooling of various types of
contractual debt. This means that it may not suffer from the same regulatory hindrances
faced by securitisations of sovereign bonds.
The actual treatment of a claim on this basket in the baseline would depend on the
specifics of the setup. Such ‘claims’ at present may take different forms (e.g., they could
be covered bonds, corporate bonds, or units in a Collective Investment (so called
Collective Investment Units or CIUs)). Their regulatory treatment, including eligibility
for an application of the ‘look through’ principle as far as CRR-driven capital
requirements, may vary accordingly.
Even though under the proper setup (i.e. as CIUs) investments in this basket may not face
unfavourable treatment in terms of capital requirements, they are still likely to face other
hindrances, especially in terms of no or incomplete eligibility for liquidity coverage
requirements (LCR).38
Thus an enabling framework would need to tackle at least these
constraining factors and could result in a standardisation of these claims (which would all
be structured to benefit from the regulatory treatment granted by the enabling
framework).
As for Option 1.1, if the product legislation would apply only to this basket (as opposed
to any conceivable basket of euro area sovereign bonds), a sizeable market for this
particular instrument is more likely to develop, thanks to the induced standardisation,
although again by no means certain. Thus, also in this case a narrower scope of
applicability may be more ’enabling’ than a wider one.
As for SBBS proper (option 1.1), this basket is by construction a product whose net
benefits would accrue to all euro-area Member States. Through it, Member States that
have a small and relatively illiquid sovereign debt market may be able to tap additional
demand. A well-developed market for such basket could also favour a more uniform
repercussion on national funding conditions from exogenous increase (say, from outside
the euro area) for euro area exposure. This would be positive for Member States that
would otherwise not benefit from this enhanced demand for euro exposure, but it is also
good for the high-rated Member States, which until now serve as "safe havens" in a
crisis, leading to higher fluctuations in their government debt interest rates and unduly
low interest rates that could lead to overheating, misallocation of investment, and to
challenges for some investor classes (e.g., pension funds).
As there is no tranching, this basket only provides diversification of risk, which on its
own is insufficient to generate a low-risk asset. We estimate that this basket would
reduce the amount of domestic bonds held by banks in a range of 3% to 34% compared
to the baseline scenario, depending on the scenario (limited volume versus steady state)
analysed (see section 5, Annex 4).
38
If structured as shares in a CIU, investments in a basket (option 1.3) would, per Article 15 of the LCR
Delegated Regulation, be eligible under certain conditions to the LCR buffer up to a maximum amount of
EUR 500 million (the amount is limited as this is a deviation from Basel intended for small credit
institutions) with a 0% haircut (as the underlying assets are government bonds), provided they respect the
general and operational requirements to be included in the buffer (amongst which historical liquidity).
30
Although this basket would exhibit much lower price volatility than individual
government bonds, its credit risk would be higher than that of many individual sovereign
bonds. The rating of such basket is not expected to be the highest possible ("AAA" in the
terminology of major credit rating agencies), with the immediate consequence that the
overall amount of AAA-rated sovereign bonds available in the euro area would sharply
decrease in the market (-25%) if such baskets were to reach a significant market size
(e.g., in the envisaged steady state scenario). In the limited volume scenario, the effect
would be smaller (-3%) (see section 4, Annex 4). In fact, assets based on this basket
would be riskier than the current portfolios of most banks.39
Inducing greater
diversification could therefore increase the total exposure of banks to sovereign risk for a
given volume of sovereign debt holdings. It is estimated that in the steady state scenario
the share of sovereign bonds rated AAA on banks' balance sheets could decrease from
24% to 19% for euro area banks (see section 4 in Annex 4). However, conversely, the
share of rather lower-rated government bonds would also decrease.
The effects of the development of a market for such a basket instrument on the liquidity
and funding conditions on national sovereign bond markets presents the same
opportunities and challenges as discussed for Option 1.1 above.
Given the specificities of this basket, the impact of option 1.3 on different stakeholders is
expected to be neutral or unclear (see also Annex 3). While there could be a positive
effect for banks, other investors and arrangers given the availability of a new
standardised product, its overall profitability is questionable. As for options 1.1 and 1.2
the impact on supervisors crucially depends on the market structure and is difficult to
predict ex-ante. The effect on DMOs and sovereign bond market liquidity is comparable
to the one of option 1.1.
6.2.4. Impact summary and conclusions
The main considerations weighing in favour or against the three options considered in
this subsection are summarised in Table 1 below.
Overall, while conceptually all securitisations and baskets of sovereign bonds would face
some kinds of regulatory hurdles, it may be preferable to specifically adapt the regulatory
framework only for one specific securitisation and one specific basket, e.g. those issued
against a portfolio respecting the "SBBS recipe" as described in Box 6 (as is the case for
the SBBS proper). This would enhance the likelihood that a structured product of euro-
area sovereign bonds becomes sufficiently traded so as to gain "benchmark"-type appeal.
39
See section 2.2 of Volume 1 of the HLTF Report.
31
Table 1: Option 1 (scope of applicability): summary assessment
6.3. Extent of ’restored’ regulatory neutrality
This section assesses whether regulatory neutrality should apply to all tranches or only to
the most senior one, i.e. whether the most favourable regulatory treatment (currently
applicable to each and every component of the underlying portfolio of sovereign bonds)
should also apply to the whole SBBS instrument. This issue does not concern the basket
(option 1.3), as there is only one ‘tranche’, or only one type of security (which is either
given equal regulatory treatment to EU sovereign bonds or not).
Consider, for example, the determination of capital requirements associated with banks'
investments in tranches of a securitisation of sovereign bonds. In this case, complete
regulatory neutrality would require setting a zero risk weight for all tranches.
Alternatively, one could give the zero risk weight only to the senior tranche40
and
positive risk weights to the sub-senior tranches, e.g. in proportion to their relative
(estimated) risk/volatility. In this case, regulatory neutrality would remain incomplete:
the regulatory playing field with euro-area sovereign bonds would become level for
senior tranche, but not for sub-senior ones.
Similar considerations could be made as regards other key aspects of legislation. For
example, one could decide to grant the same regulatory status of sovereign bonds, i.e. full
eligibility (with no haircuts) for level-1 treatment in the determination of compliance
40
Feedback from market participants has confirmed that a zero risk weight is essential for the senior tranche—
which, by virtue of its enhanced safety, is likely to have a very low yield—to be attractive for banks,
including as an alternative to holding (concentrated) portfolios of sovereign bonds.
Specific Objectives Option 1.1 Only SBBS proper
Option 1.2. All securitisations of euro
area sovereign bonds
Option 1.3 A basket of euro-are
sovereign bonds with weights in line
with ECB capital key
Ensure regulatory
playing field between
the asset and the
underlying
government bonds
(++) It addresses the identified
regulatory issues for the SBBS product.
(++) The issues arising when the
securitisation framework is applied to
securitisations of sovereign bonds are
addressed in a comprehensive manner.
(+) Gives maximum flexibility to market
participants as how to use
securitisation techniques to better
manage risk associated with
fluctuations in perceived
creditworthiness of euro area
sovereigns
(+) It addresses any regulatory issues
for the basket.
Facilitate liquidity and
benchmark quality of
the asset
(++) the narrow applicability of the
product regulation could help ensure
that all issuers of these new products
pool and tranche euro area sovereign
bonds in the same way. This would
contribute to the emergence of a
standardised product, which could
underpin greater liquidity and appeal,
including as a "natural" way for non-
euro area investors to gain euro-
denominated (low) risk exposure.
(-) the general applicability of the
product regulation would reduce the
likelihood that a (finite number of)
securitisation product(s) would emerge
as "benchmarks". This may limit the
extent to which individually any such
product would be seen as a liquid
asset. (-) Moreover, many
securitisations could combine
sovereign bonds with varying credit
ratings, without any particular criterion.
This would per se lower the "brand"
value of the product class.
(+) To the extent that the proposed
regulation would offer a more
favorable treatment to this particular
basket, it may incentivise issuers of
baskets of government bonds to pool
euro-area sovereign bonds in the same
way. This would contribute to the
emergence of a standardised product.
32
with liquidity-based requirements (such as LCR and NFSR), to all tranches of a
securitisation of sovereign bonds, or alternatively only to the senior tranche.
The considerations in favour of the former or the latter approach are discussed next.
6.3.1. Option 2.1: Extend the regulatory treatment of euro area sovereign
bonds to all tranches
Option 2.1 extends the regulatory treatment of euro-area sovereign bonds to all tranches
of an SBBS, which restores ’full neutrality’.
Full neutrality would maximize the ’enabling’ effect of the legislation:
1) From the perspective of capital requirements, assigning zero risk weights to all
tranches would, for example, allow banks to hold any given fraction of their
aggregate portfolio of euro-area sovereign bonds in the form of these tranches,
without facing additional capital requirements.
2) From the perspective of liquidity coverage requirements, full eligibility for
LCR/NFSR purposes for all tranches—would be more ’enabling’ than any other
alternative regulatory status because it would ensure that the development of an
SBBS market does not trigger a (regulatory) liquidity ’squeeze’. To understand why
this is the case, consider that at present all euro-area sovereign bonds are fully eligible
to meet the liquidity requirements (they are, in technical terms, level-1 High-Quality
Liquid Assets, or HQLA). If all tranches of a securitisation are also made eligible for
level-1 HQLA, then the supply of HQLA would not change regardless of the amount
of euro area government bonds which are assembled into these new securitisations
(that is, regardless of the volume of these new instruments).
Regarding the benefits and costs in terms of availability of AAA-rated sovereign bonds
and composition of sovereign portfolios on banks' balance sheets, the impacts are similar
to those described in section 6.2 for the SBBS proper (option 1.1) and would depend on
the scenario. In particular, in the limited volume (respectively, steady state) scenario, the
volume of AAA sovereign bonds in the euro area would increase by 2% (respectively,
30%), banks' holdings of own-sovereign bonds would decline by 3% (respectively, 34%),
and the share of AAA bonds in banks' sovereign portfolios would increase by 24%
(respectively, 32%) (see Annex 4, sections 4 and 5).
The impact of option 2.1 on different stakeholders depends on different factors, such as
the scope of applicability of the proposed legislation (see options 1.1 and 1.2) and the
market size SBBS would ultimately achieve. Overall, the positive impact on banks, other
investors and arrangers given the minimised regulatory charges may be greater if
standardisation of the product was guaranteed. As for the options discussed above, the
impact on supervisors crucially depends on the market structure that develops. As regards
the impact on DMOs, the impact depends mainly on the size/attractiveness of SBBS as
well as the structure of the national sovereign bond market. Some national sovereign
bonds may be affected more than others and the bigger the size of the SBBS market, the
larger the possible implications for national sovereign bonds. See Annex 3 (in particular
models 1 and 3) for further details.
33
6.3.2. Option 2.2: Extend the regulatory treatment of euro area sovereign
bonds only to senior tranches
Option 2.2 extends the regulatory treatment of euro-area sovereign bonds only to the
senior tranche of a securitisation.
In this case the proposed legislation would be less ’enabling’ and would (by design) level
the regulatory playing field only up to a point, i.e. only for the senior tranches.
Under this scenario, any switch by banks from direct holdings of sovereign bonds to
tranches of securitisations of sovereign bonds would result either in increased capital
requirements, or in banks having to sell off the part of their sovereign exposure
equivalent to the sub-senior tranches to keep their capital requirement unchanged. Either
way, the perceived risks faced by banks would have declined, or countered with greater
loss absorption capacity (see also Annex 3 for estimates of the impact on banks). This in
itself would be positive for financial stability considerations.
As regards government funding costs, the effects of incomplete regulatory neutrality
would depends on banks' reaction (in particular, on the extent to which banks switch their
current sovereign bond holdings into these new products), on the elasticity of supply of
bank (equity) capital, and on the elasticity of the demand by other investors for any
sovereign risk divested by banks. For example, the impact on funding costs would be
reduced, and in the limit disappear, if other investors that are not subject to capital
requirements would readily purchase sub-senior tranches sold by banks. Member States
with higher debt would be more affected by any increase in their funding costs.
Similarly, if junior tranches were not made fully eligible for HQLA status when it comes
to compliance with LCR/NFSR liquidity requirements, then the greater the amount of
such securitisations which is assembled, the larger the effective reduction of
HQLA-eligible securities available to market participants,41
which may result in
increased price for residual HQLA securities (i.e., a reduction in interest rates) and/or in
pressures for banks to increase the liquidity of their other assets (e.g., scaling down their
maturity transformation activities).
Regarding the benefits and costs in terms of availability of AAA-rated sovereign bonds
and composition of sovereign portfolios on banks' balance sheets, the impacts are similar
to those describes for option 2.1, except than the share of AAA bonds in banks' sovereign
portfolios would reach 33% under the most optimistic scenario (see Annex 4, sections 4
and 5).
As for option 2.2, the impact of option 2.1 on different stakeholders depends on different
factors, such as the scope of applicability of the proposed legislation (see options 1.1 and
1.2) and the market size SBBS would ultimately achieve (see Annex 3). As indicated
above, a more risk-sensitive treatment of the non-senior tranches would contribute to
making the overall financial system more stable. Thus the impact on supervisors is
41
Of note, and in contrast to what happens for example with the ECB's purchase programs, sovereign bonds
underpinning a securitisation would not be envisaged to be lent out for liquidity/collateral purposes—they
would be effectively withdrawn from the market as far as the total supply of HQLA is concerned.
34
expected to be positive. The impact on DMOs/sovereign bond market liquidity is unclear
depending on different variables but is overall expected to be limited (see Annex 4,
section 3).
6.3.3. Impact summary and conclusions
The considerations militating in favour of full neutrality for all tranches versus full
neutrality only for senior tranches are summarised in Table 2 below.
On balance, levelling the regulatory playing field for all tranches maximizes the enabling
nature of the proposed product legislation, and would also minimize any capital
requirement or liquidity squeeze that would result, especially in the presence of a large
switch in banks' portfolios out of direct holdings of sovereign bonds and into such
tranches. At the same time, especially for sub-senior tranches, some discrepancy might
emerge between, for example, the granted HQLA status in terms of liquidity
requirements and the actual market liquidity exhibited by the security.
Table 2: Option 2 (extent of restored regulatory neutrality)—summary assessment
6.4. Ensuring compliance with SBBS criteria and consistency in
implementation42
This section describes and assesses three policy options to ensure that any given financial
instrument complies with the eligibility criteria specified in the product legislation. This
42
Given the similarities of the issues at stake, this section draws on the impact assessment of the STS regulation
at: https://ec.europa.eu/info/publications/impact-assessment-accompanying-proposals-securitisation_en
Specific Objectives Option 2.1. Extend the regulatory treatment of
euro area sovereign bonds to all tranches
Option 2.2. Extend the regulatory treatment of
euro area sovereign bonds to senior tranches only
Ensure regulatory playing field
between the asset and the
underlying government bonds
(+) All the regulatory hindrances to the
development of markets for securitisations of
sovereign bonds are removed.
(+) The enabling nature of the regulation is
maximized, since the capacity to offer senior
tranches also depends on the demand for sub-
senior tranches (the issuers are not supposed to
retain any risk associated with their securitisation
activities)
(+) The senior tranches are given "benckmark
quality" regulatory treatment, thus ensuring them
a level-playing field with the underlying sovereign
bonds. Moreover, the differential treatment may
underscore their added safety.
(+) More "prudent" treatment of sub-senior
tranches--particularly important if the securitised
portfolio is not sufficiently diversified or heavily
exposed to low-rated sovereigns.
(-) Demand for sub-senior tranches may be less
forthcoming, especially from banks.
Facilitate liquidity and benchmark
quality of the asset
(+) No capital requirements and liquidity pressures
resulting from any switch by banks from direct
sovereign bank holdings to tranches of
securitisations of sovereign bonds--banks'
incentive to switch is maximized.
(+) No aggregate "liquidity squeeze" that would
result if assembling securitisations of sovereign
bonds would reduce HQLA level-1 eligible assets.
(-) A mismatch might emerge between the
regulatory treatment of a securitisation tranche as
liquid and its actual liquidity exhibited in the
marketplace--this is especially likely for sub-senior
tranches, in particular those issued against non-
diversified portfolios.
(+) The differential regulatory treatment could
underscore the enhanced safety of senior
tranches. Especially if a standardised senior
tranche emerges in the market, it may more
naturally become a benchmark.
35
is a crucial aspect for investors' trust, which is itself particularly important in determining
the chances of success of a completely novel product. Irrespective of the decision taken
on the options described in this section, four general principles must apply and contribute
to the proper implementation of the product legislation.
(a) Ensuring investors' due diligence (investors' responsibility): The compliance
mechanism is not intended to provide an opinion on the level of risk embedded in the
securitisation, nor any guarantees of payouts. The scope of the compliance
assessment should be strictly limited to criteria establishing the 'foundation approach',
namely applying to the structure of the instrument. Investors should continue
performing careful due diligence of any securitisation of sovereign bonds before
investing.
(b) Responsibility to comply is first on originators. Originators (or arrangers) of SBBS
instruments should bear primary responsibility toward ensuring that their product
fulfils the criteria. They will have to attest that the product is meeting all SBBS
criteria. The onus would remain on originators as they are in possession of the most
complete information regarding the product and are the best placed to make the
determination on the characteristics of the instruments.43
In addition, if the originator
is found liable for misleading or false attestation, sanctions on originators would be
much more effective than sanctions on the securitisation vehicle itself.
(c) Sanctions should be in place for non-compliance. There is a need for appropriate
sanctioning measures for participants in the SBBS market to set the right incentives.
For originators, the measures would refer to normal supervisory sanctioning powers.
Sanctions should be both proportionate and dissuasive to prevent investors being
misled and could range from pecuniary fines to a prohibition against further issuances
for a pre-determined period of time. There is also a need to consider the implications
on investors (e.g. what happens if a securitisation is re-qualified as non-qualifying for
the new regulatory treatment). Investors would, for example, no longer benefit from
incentives attached to the 'SBBS category'. In this case, a transitional period could be
foreseen for investors, e.g. to prevent fire-sales. Specific sanctions should also be
applied to any independent third parties involved in the process.
(d) Appropriate public oversight. In the course of their regular assessments of
prudential requirements (e.g. onsite/off-site examination of solvency requirements),
supervisors will verify compliance with the eligibility criteria. This monitoring is
important to ensure the accuracy of prudential ratios, since these new products would
benefit from a specific prudential treatment. Specific monitoring arrangements should
also be defined for originators of SBBS instruments—especially if they are not
already under supervision, for example by virtue of not being banking entities—and
for potential third parties.
6.4.1. Option 3.1: A compliance mechanism based on self-attestation
Under this option, the responsibility for determining compliance with SBBS criteria
would lie with originator firms, which would be legally liable for attesting that all criteria
43
This information advantage is however very limited in the case of either SBBS or the basket, since the
underlying assets—i.e., euro-area government bonds—are well known to all investors, and they are routinely
traded (so that a relevant price signal is in nearly all circumstances available).
36
were met. They would be required to disclose this attestation in the offer documents after
an appropriate assessment of each of the criteria. Ex-post oversight would be carried out
as in normal supervisory activities. The eligibility of an SBBS securitisation for the
envisaged prudential treatment would therefore still be subject to supervisory checks.
(a) Effectiveness
The attestation would establish legal liabilities for originators, which would create a
safeguard for investors. This approach would not fully eliminate investors' concerns
about conflicts of interests by originators that may affect the objectivity of their
attestation. Therefore misleading self-attestation is the main risk of this approach. Yet it
needs to be kept in mind that, given the specialness of the underlying assets (i.e., euro-
area government bonds), there is little if any scope for discretion on the part of the
originator in how to assemble the product, especially when the "recipe" is basically given
(as is the case under Options 1.1 and 1.3). The risk can be further lowered by ensuring
that false self-attestation would have serious consequences for the originators if unveiled
for example in the course of an inspection by supervisors.
These supervisory checks, which could be carried out on a risk basis, would provide the
overarching guarantee of the correct functioning of the system
Nevertheless, incentives would remain for investors to carry out due diligence (again,
this is expected to be not too involved, thanks to the nature of assets underlying these
new structures and the (simple) requirements to qualify for the envisaged regulatory
treatment. Needless to say, due diligence on the part of investors is key for a safe and
sustainable market.
This approach does not limit in any way the recourse to validation by third parties of a
deal's SBBS status. If the latter will provide value added to investors and originators,
they will require it and a market will arise. It should be noted that, given the specialness
of the new products, the role of a third-party validator would likely be quite limited,
possibly to merely confirming that the structure does contain the stated sovereign bonds
in the stated quantities (and thus confirm, quite trivially, whether these align or not with
the ECB capital key). Differently from other securitisations, in other words, third-party
validators would not need to offer opinions nor due extensive diligence on the underlying
assets, as these are well-known.
(b) Efficiency and impact for stakeholders
This option would increase originators' liability in case of wrongdoing, while maintaining
investors' due diligence incentives. Since supervisors would only be involved ex-post
when reviewing prudential requirements, it could be argued that this setup would
minimize expectations on the part of investors of "bailout" by public entities if something
goes wrong (compared to a setup where investors buy the new product on the basis of a
certification by a public entity—see option 3.3 in section 6.4.3). In addition, third parties
could anyhow be involved in the compliance mechanism if the markets value such an
involvement and are therefore willing to pay for it. This option will therefore not limit in
any way the development of third party validation schemes. If these will provide value
added to investors, these should require it and issuers should adapt.
37
This approach would have limited novel financial implications for public budgets, since
supervisors would check compliance ex-post in the course of their routine supervisory
activities. Originators would have to support the self-attestation costs, which should
however be quite small (the extent to which these are translated to investors would
depend on the competitiveness of the market). In the absence of an ex-ante public
intervention, this approach would not eliminate regulatory risks for investors as
self-attested SBBS instruments could be re-qualified at a later stage.
6.4.2. Option 3.2: Option 3.1, with the involvement of third-parties
Similar to option 3.1, option 3.2 would rely on self-attestation by originators. It would,
however, be complemented by the mandatory involvement of a third party, for
certification and/or for management purposes. As investors may have concerns with
fraudulent declarations by originators, they might view self-attestation as not sufficient to
build the critical amount of trust for the SBBS market to take off. A control system
relying on independent third parties could thus be established to prevent the issuance of
non-compliant SBBS instruments.
This option could build on EU procedures in place to establish labelling in other areas.44
'Control bodies' could be designated to perform specific checks to assess compliance with
the eligibility criteria. These bodies would in turn respect requirements defining the
nature, frequency and conditions of their controls. A specific oversight or licensing
regime would have to be developed in order to authorise and monitor these independent
bodies.
(a) Effectiveness
Under option 3.2, the self-attestation would be complemented by an independent review
of compliance with the eligibility criteria. This approach would help address any
concerns related to the truthfulness of originators' prospectuses, providing additional
confidence to investors. Appropriate safeguards would be needed to prevent and address
potential conflicts of interests with originators, especially if third parties were to rely on
"issuer-pays" models.
If properly performed, third-party reviews would give additional assurance to investors.
The drawback is that the third-party review may induce lower scrutiny and due diligence
by investors. It should be noted that, in the case of tranched products, to some extent
relieving investors of the need to do due diligence could be considered as part and parcel
of the creation of a "liquid low-risk asset", as arguably one feature of such an asset is that
it can and will be traded with "no need to ask questions". To the extent however that
sub-senior tranches are not standardised, reducing incentives for due diligence by
investors can be suboptimal.
(b) Efficiency and impact for stakeholders
This option would rely on private sector entities to perform independent assessments of
SBBS. Several entities may enter into this market and competition could limit the costs
44
For instance for organic products (i.e. Council Regulation n°834/2007)
38
for issuers. Involving private entities would make the mechanism more flexible and
scalable to market activities. However, it would also imply additional costs, though as
discussed these could be expected to be small since the third-party validator/reviewer
merely needs to confirm that the content of the structure is exactly as advertised in the
prospectus.
This approach would have similarities with other EU policy, in particular the procedures
for EU labelling. Public oversight of the independent entities could also build on the
approach developed for the registration and oversight of credit rating agencies. It is
important to note that this approach may present similar issues and risks causing
'overreliance' on third parties, as has arguably been the case with credit rating agencies.
Originators and investors may favour this option, if they would share part of the
liabilities with third parties. Their increased confidence notwithstanding, investors would
not get full regulatory certainty, as the final prudential determination of compliance
would remain with the supervisors.
6.4.3. Option 3.3: Option 3.1 with ex-ante supervisory checks on each
issuance
Similar to option 3.1, option 3.3 would rely on the self-attestation of originators,
complemented by ex-ante checks by supervisory authorities. This option would offer a
higher degree of credibility due to the specific status of supervisory authorities.
Furthermore, prudential authorities benefit from a wider overview of market practices
and are less likely to be subjected to issues related to information asymmetries.
Moreover, with no ’issuer-pays’ model, no conflicts of interest should arise.
This approval mechanism would be developed for each issuance of the new instrument.
This would ensure that each individual issuance meets the eligibility criteria. Compared
to the previous options it would, however, imply higher compliance costs for securities
regulators, but again should not be too expensive because of the simple nature of the
instrument and its underlying assets. Checking the legal setup, for example in terms of
the correct specification of the waterfall of payments in case of an SBBS proper, may be
more costly. But it is likely that a standard setup would emerge, reducing such
monitoring costs over time.
Alternatively, an 'issuer-based approach' could be developed. This would mainly focus
on processes implemented by originators to ensure compliance with eligibility criteria.
This would result in a kind of license granted by the authorities. The initial licensing or
approval would be comprehensive and detailed, and thus somewhat more resource
intensive, but it would reduce the subsequent compliance costs, as originators would not
be required to renew approval for every new transaction. This setup would thus favour
large originators, which could amortise the licensing costs over larger volumes.
(a) Effectiveness
Instead of relying on independent third parties, supervisors would directly assess the
compliance with eligibility requirements. This approach would be the most powerful to
ensure investors' confidence. This option would contribute to a sustainable development
of these new markets, while reducing the risks of confidence crises and attendant
spillovers, which in the limit could jeopardise financial stability.
39
However, reliance on supervisors would reduce substantially investors' incentives to
perform thorough due diligence. It could also generate expectations of "bailouts", should
the products experience difficulties. Also, this would reduce the responsibility of issuers,
as supervisory approval would be necessary.
(b) Efficiency and impact for stakeholders
This option would be the most efficient in terms of ensuring the credibility of the new
products. However, it would require greater public resources as supervisory authorities
would have to take on new tasks. These costs would, of course, be minimized if the
"SBBS proper" model is chosen, whereby detecting non-compliance with the given
"recipe" (i.e., portfolio weights and tranching levels) would be relatively straightforward.
While investors and originators may appreciate the legal certainty associated with a
supervisory review, supervisory authorities may face additional liabilities and concerns
about moral hazard issues.
6.4.4. Impact summary and conclusion
Fejl! Henvisningskilde ikke fundet. summarises the relevant considerations.
Table 3: Option 3 (Compliance mechanism)—summary assessment
Option/
Specific
objectives
Option 3.1:
Compliance mechanism
based on self-attestation
by originators
Option 3.2:
Option 3.1 with the
involvement of third-
parties
Option 3.3:
Option 3.1
complemented by ex-
ante supervisory checks
on each issuance
Effectiveness (=) Investor confidence
would depend on
reputation of issuer and
potential sanctions
(++) Reduced "moral
hazard" risks as
incentives for due
diligence remain high
(+) Investor confidence
would be increased as
independent assessment of
eligibility criteria will be
available
(-) Increased "moral
hazard" risks as incentives
to investors' due diligence
are weaker
(++) Strong and positive
effects on investor
confidence
(--) Increased "moral
hazard" risks as investors
might come to expect
public backing for the
product.
Efficiency (+) Limited costs for
public finance and public
authorities resources.
(+) Higher flexibility and
scalability of the process
(-) Additional costs for
originators and need to
introduce public oversight
for 3rd
parties
(-) Public authorities
would need more
resources to take up new
tasks
Impact on
stakeholders
(+) Better alignment of
incentives between
originators and investors
(liability for potential
risks)
(-) Investors would not
benefit from external
support in assessing
compliance with
eligibility criteria.
(+) Would provide
additional confidence to
investors in assessing
compliance with eligibility
criteria
(-) Even with 3rd
parties
involved, final prudential
decisions would remain a
competence for
supervisors
(=) Greater legal certainty
for investors-originators,
but concerns on the
scalability and timeliness
of the mechanism
(-) Potential reputation
risks for public authorities
40
Although the extent of asymmetric information between originators on one side and
investors/supervisors on the other is even less than in the case of the STS securitisation,
Option 3.1, i.e. attestation by originators, comes across also here, like in the case of the
STS securitisations, as the preferred setup to ensure compliance with the eligibility
criteria of the new products. This setup would ensure that originators remain liable for
issuing instruments meeting eligibility criteria and should incentivise investors to
perform appropriate due diligence, while minimizing novel costs on supervisors (as well
as moral hazard concerns). Issuers should face appropriate sanctions if they make wrong
declarations. This approach could be combined with option 3.2, but on a non-mandatory
basis. Originators would still have the possibility to ask for a review by an independent
third party if they consider that this would provide added value.
7. HOW DO THE OPTIONS COMPARE?
The options described in the previous section can be combined to form "models" which
in turn can inform the proposed product legislation.
Figure 5: The decision tree
41
In particular, Figure 5 shows how combining the options considered in terms of scope of
applicability of the legislation (section 6.2) and extent of restored regulatory neutrality
(section 6.3) generates five distinct models, which will be compared in this section. Note
that the arguments underpinning the superiority of the self-attestation model (Option 3.1)
as setup to ensure compliance with the proposed legislation are largely independent of
the options considered in sections 6.2 and 6.3. Therefore Option 3.1 would be used
regardless of the specific model chosen, and it is not discussed further in what follow.
The comparison among the five models with the baseline (no regulatory intervention) is
summarised in Table 4. The first two rows of the Table capture the extent to which each
model advances the achievement of the specific objectives set out for the legislative
intervention, namely securing "regulatory neutrality" for the new product vis-à-vis euro
area sovereign bonds and facilitating their liquidity (de jure and de facto) and scope for
becoming "benchmark-like" instruments. The other rows assess the various models
against other desirable objectives.
Table 4: Assessment
The different models perform differently against the various criteria. In particular,
models 1, 2 and 5 (in which the legislation would apply to products with pre-specified
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as
euro area sovereign
bonds
Only SBBS proper;
Treat only Senior
tranches as euro area
sovereign bonds
All securitisations;
Treat all tranches as
euro area sovereign
bonds
All securitisations;
Treat only Senior
tranches as euro area
sovereign bonds
Proper SBBS basket;
Treat basket as euro
area sovereign bonds
Regulatory Neutrality yes partial yes partial yes
Liquidity/benchmark
quality
yes yes no no partial
Minimizes capital
requirements?
yes for SBBS
no, sub-senior
tranches would still
command high risk
weights for SA banks
yes
no, sub-senior
tranches would still
command high risk
weights for SA banks
yes
Assembling of the
product does not
result in reduction of
HQLA assets
yes no yes no yes
Does not impair
liquidity of national
sovereign bond
markets
Ambiguous (*). Effects
likely to be small if
market size is limited
Ambiguous (*). Effects
likely to be small if
market size is limited
Effects (if any) likely
to be small.
Effects (if any) likely
to be small.
Ambiguous (*). Effects
likely to be small if
market size is limited
Helps expand amount
of low-risk assets
yes, senior SBBS is
low-risk
yes, senior SBBS is
low-risk
uncertain uncertain no
Facilitates banks'
diversification
yes yes
uncertain, it depends
on what product is
developed
uncertain, it depends
on what product is
developed
yes
Facilitates cross-
border financial
integration
yes especially thanks
to the standardization
yes especially thanks
to the standardization
yes yes yes
Facilitates bank de-
risking
yes
yes, and more than
Model 1, since there
would be a built-in
incentive to offload
junior tranches
uncertain, it depends
on what product is
developed
uncertain, it depends
on what product is
developed. But more
than Model 3, since
there would be a built-
in incentive to offload
junior tranches
uncertain, as it
depends on the
product. Less than
Model 2, since the
asset would be
diversified, but
without the
protection of the
junior tranche
Facilitates smooth
absorption of
asymmetric capital
flows
yes yes
uncertain,
it depends on what
product is developed
uncertain,
it depends on what
product is developed
yes
Effectiveness
Other positive
effects
42
structures) would fare better than models 3 and 4 (in which the proposed product
legislation would apply to any and all securitisations of euro-area sovereign bonds) in
developing a standardised product, which – as also underlined by stakeholders in the
ESRB public consultation (see Annex 2, section 1) and industry workshop (see Annex 2,
section 2) – is key for the liquidity and attractiveness of the new product.
Models 1 and 2, allow the creation of a new euro-denominated, euro area representative
low-risk synthetic asset (the senior tranche), which could over time compete in the
international financial markets with such benchmarks as bonds from the US or Japan
(Models 3 and 4, which lack standardisation, would not).
Model 5, despite featuring standardisation, does not quite achieve that, because it does
not feature tranching (and thus added "protection" to at least the senior tranche). Indeed,
Model 5 could over time even result in an aggregate reduction of AAA-rated assets (see
Annex 4.4). It might also not deliver on de-risking banks' bond portfolios as assets based
on this basket would be riskier than the current portfolios of most banks, thus banks
would have no incentive to swap into this asset. On the other hand however, it offers the
very positive feature of avoiding the complexities associated with securitisations45
(which Models 3 and 4 would not).
So, the choice between Models 1 and 2, on one hand, and Model 3 on the other, comes
down to the relative importance attached to creating a synthetic low-risk asset versus
keeping things simple.
The choice between Models 1 and 2 comes down to a trade-off between maximizing the
"enabling" effect of the proposed regulation (Model 1) versus maximizing its financial
stability benefits (Model 2).
By providing the most favourable regulatory treatment to all tranches, thus for example
ensuring that the development of SBBS markets does not adversely affect banks' access
to high-quality liquid assets, Model 1 is by definition more "enabling" than Model 2.46
Model 2, however, could give greater benefits in terms of overall risk reduction if it led
to a transfer of riskier sovereign exposures from banks to other investors which are better
equipped to handle them and whose financial difficulties would not be expected to put
any direct pressure on public finances of individual Member States.47
Of course, a
necessary condition for this "good equilibrium" to emerge would be that SBBS would
prove economically viable even in the presence of remaining regulatory hindrances of
various types on sub-senior tranches.
45
E.g., properly enforcing the waterfall of payments in the case some underlying bonds experience debt service
difficulties.
46
Recall that, for senior tranches to be "produced", issuers/arrangers have to be confident that sufficient demand
also comes forth for sub-senior tranches.
47
It may be worthwhile noting that setting out incentives whereby banks would not want to hold sub-senior
SBBS tranches (as would be the case in Model 2) does not mean that banks' total exposure to EU sovereign
risk must necessarily decline, as banks could decide to switch their entire current holdings of EU sovereign
bonds into senior SBBS. Again, as discussed in Section 6.3.2, the net effects on the funding costs of euro-
area sovereigns would depend on several factors, including the elasticity of demand for sub-senior SBSB by
investors not subject to CRR requirements (e.g., hedge funds).
43
8. PREFERRED OPTION
8.1. Preferred model
Our analysis shows that, given the importance of standardisation for the development of
a benchmark-type asset, Models 3 and 4 are likely to be inferior.
As far as the remaining models are concerned, however, each has different strengths in
addressing different issues. No clear conclusions thus emerge from the analysis as to a
single best model (understood as a single collection of best options) in terms of both
effectiveness and efficiency. Political considerations will be required, therefore, to
prioritise the choices, based on the impacts and trade-offs presented in the preceding
sections.
Regarding the regulatory treatment of the different tranches of the product, Model 1
would restore full regulatory neutrality, which would maximize the ’enabling’ effect of
the legislation. Model 2 would be less ’enabling’ than model 1 and would (by design)
level the regulatory playing field only up to a point, i.e. only for the senior tranches. It
might, however, lead to greater de-risking by banks, and thus greater financial stability
benefits, if—despite the higher charges on sub-senior tranches—SBBS nevertheless
proved viable. Model 5 would be enabling to the extent only that it is de facto the
regulatory treatment that is currently hindering the instrument's natural emergence.
Regarding the choice of the compliance mechanism, as with the STS securitisation, a
model based on attestation by originators, possibly complemented by third party
certification on a voluntary basis (option 3.1 in section 6.4), is the preferred option as it
would ensure that originators remain liable for issuing instruments meeting eligibility
criteria and incentivise investors to perform appropriate due diligence, while minimizing
novel costs on supervisors (as well as moral hazard concerns).
8.2. REFIT (simplification and improved efficiency)
This initiative introduces new rules for a new financial instrument, namely SBBS. This
initiative simplifies the regulatory treatment of this instrument and should enable the
development of a new market. Simplification concerns several aspects, including the
restrictions on investing in these instruments by some financial institutions.
9. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?
In terms of securing the specific objectives (i.e., eliminate regulatory hindrances and
contribute to the liquidity of the new products, including by granting them "benchmark"
regulatory treatment), if either model 1 or 3 is chosen, all that can be achieved by
legislation is indeed achieved once the proposed legislation is approved and enters into
force (because only a standardised product would then be made eligible, capital
requirements would be effectively eliminated, and the best possible treatment as far as
liquidity coverage requirements would be granted). For model 2, which would involve
some calibration (e.g., for the risk weights of sub-senior tranches for pillar-1 capital
requirement purposes), regular monitoring after sufficient data has become available
(say, in three or five years) would be helpful to ascertain whether the calibration chosen
remains appropriate.
44
In terms of the general objective to enable markets for these new products, (i.e., SBBS or
baskets, depending on the model ultimately chosen) the impact of the legislation will be
assessed by monitoring the extent to which these new products will be actually
assembled and traded, and—in turn—how much they contribute to the benefits measured
by the benchmarks presented in section 6.1.2 (e.g., expanding the amount of low-risk
assets, reducing the "home bias" in banks' sovereign bond portfolios, etc.). Information
on the amount of SBBS assembled and traded is expected to be readily available,
including because of the envisaged notification and registration requirements for each
issuance. As regards the other benchmarks, data on the aggregate amount of
euro-denominated low-risk (e.g., AAA-rated) instruments, or on the ratio between banks'
holdings of bonds issued by their own government relative to their total holdings of
sovereign bonds, or on the relative share of highly-rated sovereign bonds on banks'
balance sheets are also readily available. The extent of their impact on the liquidity of
national sovereign bond markets will also be assessed, using traditional measures of
liquidity (e.g., bid-ask spread, volume traded, etc.). It is proposed that the Commission
produces a report five years after the entry into force of this regulation, and at 5-yer
intervals thereafter.
When interpreting the results of the afore-mentioned monitoring activities, it needs to be
kept in mind, however, that both the development of this new market and the evolution of
most if not all of the above-mentioned benchmarks depend on several other factors which
are independent of, or may be only tenuously linked to, the regulatory framework. This is
likely to make it difficult to disentangle the effects of the proposed legislation per se. In
particular, for example, the supply of new products is also likely to depend on such
factors as the legal costs (i.e., lawyers' fees) of setting up the issuing vehicle, the ease of
procuring bonds of sufficiently uniform terms on either the secondary or primary market,
the costs of servicing the structure, etc. Similarly, the demand of SBBS will depend on
the overall interest rate environment, the risk appetite, and the demand from various
investor types for the different tranches, etc. Market developments may also well be non-
linear, as it is in the nature of the envisaged product that it benefits from returns to scale
from size and network externalities. Thus, for example, if the product appears to attract
sufficient investor interest, it is possible that debt managers may decide to organise
dedicated auctions for the production of SBBS, with standardised bonds of varying
maturities. This would, in turn, reduce production costs and could accelerate the growth
of the market.
45
LIST OF REFERENCES
Altavilla, C., Pagano, M., & Simonelli, S. (2016), "Bank exposures and sovereign stress
transmission", Working Paper 11, European Systemic Risk Board.
Banca d'Italia (2014), "The negative loops between banks and sovereigns", occasional
papers, number 213, by Paolo Angelini, Giuseppe Grande and Fabio Panetta,
http://www.bancaditalia.it/pubblicazioni/qef/2014-0213/QEF_213.pdf.
Basel Committee on Banking Supervision (2017), "The regulatory treatment of sovereign
exposures", Discussion Paper (December 2017), https://www.bis.org/bcbs/publ/d425.htm
Bessler, W., A. Leonhardt and D. Wolf (2016). “Analyzing hedging strategies for fixed
income portfolios: A Bayesian approach for model selection.” International Review of
Financial Analysis, Forthcoming.
Brunnermeier, M.K., L. Garicano, P. Lane, M. Pagano, R. Reis, T. Santos, D. Thesmar, S.
Van Nieuwerburgh, and D. Vayanos (2016a). “The sovereign-bank diabolic loop and
ESBies.” American Economic Review P&P, 106(5): 508-512.
Brunnermeier, M., S. Langfield, M. Pagano, R. Reis, S. Van Nieuwerburgh and D. Vayanos
(2016b), ESBies: Safety in the tranches, No 21, ESRB Working Paper Series, European
Systemic Risk Board, https://www.esrb.europa.eu/pub/pdf/wp/esrbwp21.en.pdf
De Marco and Macchiavelli (2016), "The political origin of home bias: the case of Europe",
Finance and Economics Discussion Series, Federal Reserve Board, 2016-060.
Erce. A (2015), "Bank and sovereign risk feedback loops", Working Paper Series 1, ESM,
https://www.esm.europa.eu/sites/default/files/esmwp1-09-2015.pdf.
European Commission (2017), "Reflection paper on the deepening of the economic and
monetary union", https://ec.europa.eu/commission/publications/reflection-paper-deepening-
economic-and-monetary-union_en.
European Systemic Risk Board High-Level Task Force on Safe Assets (2018a), "Sovereign
bond-backed securities: A feasibility study", Volume I, January 2018,
https://www.esrb.europa.eu/pub/task_force_safe_assets/shared/pdf/esrb.report290118_sbbs_
volume_I_mainfindings.en.pdf.
European Systemic Risk Board High-Level Task Force on Safe Assets (2018b), "Sovereign
bond-backed securities: A feasibility study", Volume II, January 2018,
https://www.esrb.europa.eu/pub/task_force_safe_assets/shared/pdf/esrb.report290118_sbbs_
volume_II_technicalanalysis.en.pdf.
Gao, P., P. Schultz and Z. Song (2017). “Liquidity in a market for unique assets: specified
pool and to-be-announced trading in the mortgage-backed securities market.” Journal of
Finance, 72(3): 1119-1170.
Guembel and Sussman (2009), "Sovereign Debt without Default Penalties", Review of
Economic Studies, 76, 1297–1320.
Horváth, B L, H Huizinga, and V Ioannidou (2015), "Determinants and valuation effects of
the home bias in European banks' sovereign debt portfolios", CEPR Discussion Paper 10661.
Juncker, J.-C. (2017a), "State of the Union Address 2017", 13 September 2017,
SPEECH/17/3165, http://europa.eu/rapid/press-release_SPEECH-17-3165_en.htm
46
Juncker, J.-C. (2017b), "Letter of intent to President Antonio Tajani and to Prime Minister
Jüri Ratas", 13 September 2017, https://ec.europa.eu/commission/sites/beta-
political/files/letter-of-intent-2017_en.pdf
Persaud (2017), speech at the Nex Conference on the Future of European Government
Bonds, Brussels, 7 November 2017: "Local assets are a good hedge against liabilities linked
to the government and local inflation. It is appropriate that risk-takers take risks with which
they are most familiar".
Schlepper, K., Hofer, H., Riordan, R. and Schrimpf, A. (2017), “Scarcity effects of QE: A
transaction-level analysis in the Bund market.” Deutsche Bundesbank Discussion Paper no.
06/2017.
Schneider, M., Lillo, F. and Pelizzon, L. (2016). “How has sovereign bond market liquidity
changed? An illiquidity spillover analysis.” SAFE Working Paper no. 151.
Schönbucher, P. J. (2003). “Credit Derivatives Pricing Models: Models, Pricing and
Implementation.” London: Wiley.
47
ANNEX 1 PROCEDURAL INFORMATION
1. LEAD DG, DeCIDE PLANNING/CWP REFERENCES
Directorate-General for Financial Stability, Financial Services and Capital Markets
Union (DG FISMA).
DECIDE FICHE PLAN/2017/1678
2. ORGANISATION AND TIMING
Adoption expected in May 2018
3. CONSULTATION OF THE RSB
An upstream meeting was held on 20 October 2017.
The draft report will be sent to the Regulatory Scrutiny Board (RSB) on 19 January 2018.
The RSB meeting took place on 14 February 2018.
The RSB delivered a positive opinion with reservations on 16 February 2018.
4. EVIDENCE, SOURCES AND QUALITY
This impact assessment is based primarily on the analysis done by the ESRB HLTF. The
report of the ESRB HLTF was published on 29/01/2018. The European Commission
(DG FISMA and DG ECFIN) contributed intensively to the overall analysis of the HLTF
and its report. The assessment is based on analytical analysis, a public stakeholder
consultation, a stakeholder workshop and bilateral meetings with stakeholders.
In particular these include the following:
 A dedicated industry workshop was held in Paris in November 2016
(https://www.esrb.europa.eu/news/schedule/2016/html/20161209_esrb_industry_
workshop.en.html).
 A public survey/questionnaire was run on the ESRB website at the end of 2016/
early 2017 (https://www.esrb.europa.eu/mppa/surveys/html/ispcsbbs.en.html).
 A workshop to gather the views of the Public Debt Managers (DMOs) was
conducted in Dublin on 20 October 2017.
 Statistics and data from various sources, including ECB, EBA, Eurostat.
 Academic (economic) literature (see List of References of the ESRB HLTF report
volume I and II, as well as of this document).
For a detailed description of the methodological approach, analytical methods, and
limitations of the evidence underpinning this impact assessment, see Annex 4.
48
ANNEX 2 STAKEHOLDER CONSULTATION
As part of its feasibility assessment of SBBS, the HLTF has conducted a public
consultation in late 2016 on the ESRB website, and has sought input and feedback from
the industry and from Public Debt Managers (DMOs), including through two dedicated
workshops, respectively an open one in November 2016 in Paris and a closed-door one in
October 2017 in Dublin. The outcomes of these consultations are presented in this annex.
On this basis, and considering that the proposed initiative, by its very nature, would not
directly affect retail consumers or investors, it has been decided that no further public
consultation is necessary.
1. RESULTS FROM THE ESRB PUBLIC SURVEY ON SOVEREIGN BOND-BACKED
SECURITIES48
The ESRB HLTF on safe assets ran an industry survey to consult with stakeholders on
various open questions regarding the possible implementation of SBBS. The
questionnaire sought feedback on several key issues that have been identified internally
by the task force, as well as some concerns that have arisen following the bilateral market
intelligence meetings. The survey was published on the ESRB website on
22 December 2016 and closed on 27 January 2017.
The survey received 15 credible responses from four investment banks, three commercial
banks, four asset managers, three funds and one clearing house. The raw data has been
carefully analysed and various useful insights have emerged. Overall the responses were
in line with feedback that task force members have received in bilateral meetings, but
some unexpected responses were also given (such as on the expectations for the senior
bond’s credit rating). A breakdown of answers on key questions and general conclusions
drawn from the survey are shown below.
1.1 Senior SBBS
To what extent do you perceive a shortage of low-risk and highly liquid euro assets?
Respondents seem to agree that there is an issue with the supply of safe assets.
Answer Breakdown:
2 felt that there is Considerable Shortage
8 felt there is Partial shortage
4 do not believe that there is a shortage of safe assets. In particular 1 highlighted that
there is “No shortage in terms of availability - the price is just high, but low-risk and
highly liquid assets can always be purchased”.
1 did not answer
In which asset class would you categorise senior SBBS?
There seems to be a division amongst market participants as to the asset classification of
SBBS. This is not inconsistent with the feedback received in Paris and bilateral meetings,
48
Prepared by staff of the ESRB's Secretariat. The survey itself is introduced at this address:
https://www.esrb.europa.eu/mppa/surveys/html/ispcsbbs.en.html and presented here:
https://epsilon.escb.eu/limesurvey/123521?lang=en
49
as many admitted that they could see arguments for an SBBS being both a bond and a
structured product.
Answer Breakdown:
6 perceive it is a government/supranational bond only
6 perceive it as a structured product only
3 perceive as both a bond and a structured product
One respondent noted that for the Senior SBBS to be classified as a government bond it
would need to meet structural (“fixed rate, bullet nominal”), regulatory (“ECB collateral,
solvency capital for banks and insurance equal to govies”) and market transparency
(“rules of issuance, timing”) requirements.
There are several ways to measure credit risk. How would you score these different
risk measures in terms of their usefulness for evaluating the properties of senior
SBBS?
Very
Useful
Useful Partly
Useful
Not
Useful
No
Answer
Probability of Default 7 4 0 0 3
Expected Loss 7 3 1 0 3
Value at Risk 4 6 2 0 2
Expected Shortfall 3 4 2 0 5
Marginal Expected Shortfall 1 4 1 1 7
CoVar 2 4 1 0 7
If you have chosen “other” in question 3, above, please elaborate on the additional
risk measure to which you referred.
Two respondents indicated that different risk metrics to the one above would be very
useful. Specifically one referred to the relationship of SBBS with the euro swap rate. The
other hinted on the importance of “Stress loss under extreme but plausible market
conditions” and default correlations.
One respondent indicated that “Markets would probably price this on an expected loss
basis (CDO type pricing).”
What spread (in basis points) would you expect in the yield-to-maturity of 10-year
senior SBBS relative to 10-year benchmark German bunds? If possible, specify the
precise expected spread in the free text box.
Answer Breakdown:
1 Between -50bp and 0bp
7 Between 0bp and 50bp
4 Between 50bp and 100bp
2 Did not answer
Which long-term credit rating would you expect to be assigned to senior SBBS?
At the Paris workshop, several participants expressed scepticism that senior SBBS could
achieve a AAA rating. However, most survey respondents felt that senior SBBS would
be rated AAA.
50
Answer Breakdown:
8 AAA
7 AA
Low-risk assets typically appreciate in value during periods of stress. If perceived
sovereign risk were to increase, would you expect the value of senior SBBS to
increase, stay the same, or decrease?
Surprisingly, respondents were split on this question. Analytical work done by experts of
the task force indicates that there is negative correlation between the yields of the
tranches in stress times. Investors would flee from riskier securities and seek haven in
safe assets. Respondents do not unanimously share this finding, however.
Answer Breakdown:
6 Increase
5 Decrease
1 Other: “Decrease if Eurozone crisis”
3 Did not answer
How important is the liquidity of senior SBBS?
Respondents perceive liquidity of the senior bond as Very Important. This is in line with
the feedback perceived in bilaterals and in Paris.
Answer Breakdown:
13 Very Important
2 Did not answer
To ensure adequate liquidity of senior SBBS, which categories of maturities would
need to be issued?
There seems to be a slight preference from respondents for the term structure of SBBS
should cover the most liquid points vs the entire curve.
Answer Breakdown:
6 Issuance at most liquid points of the curve
5 Issuance at all points of the curve (from the very short to the very long end)
4 Did not answer
To ensure adequate liquidity of senior SBBS, to what extent is it important for them
to be highly standardised? Or could there be some degree of flexibility (e.g.
regarding portfolio weights)?
Respondents clearly prefer a high standardisation of SBBS, which reflects the importance
of homogeneity across different SBBS series.
Answer Breakdown:
9 High standardisation – the prospectus should fix portfolio weights with no scope for
deviation
4 Medium standardisation – the prospectus should allow only very limited deviation
(within a small min/max range)
2 Did not answer
51
What is the minimum total notional value of senior SBBS necessary to ensure
adequate liquidity?
Respondents do not seem to agree on an exact figure but consensus is that the notional
should be relatively high. Specifically, most agree that any size below 250bn will not
result in a liquid enough market. A relatively high number of participants did not answer
this question.
Answer Breakdown:
2 More than 1500bn
1 Between 1000-1250bn
2 Between 500-750bn
2 Between 250-500bn
2 Less than 200bn
6 Did not answer
What is the minimum monthly issuance of senior SBBS (in terms of notional value)
necessary to ensure adequate liquidity?
Similar to the previous question, there is no clear answer as to what precise monthly
issuance size can guarantee adequate liquidity. It seem that a target around the
EUR 10 billion mark could suffice. A relatively high number of participants did not
answer this question.
Answer Breakdown:
1 More than EUR 20 billion
2 Between EUR 15 billion and EUR 20 billion
4 Between EUR 10bn and EUR 15 billion
2 Between EUR 5 billion and EUR 10 billion
1 Less that EUR 5 billion
5 Did not answer
Why might your institution hold senior SBBS?
Responses
Asset-Liability Management (of maturity mismatch) 5
Collateral 8
Investment Return 4
Liability-driven Investment 2
Liquid store of value 9
Regulatory requirements 7
Safe store of value 4
Assuming that senior SBBS are designed such that they meet your requirements in
terms of credit and liquidity risk, what percentage of your institution’s current
holdings of central government debt could be replaced by senior SBBS?
Overall it seems that the substitutability should be quite low in absolute values but it is
very consistent with an incremental approach to SBBS market development. Answers to
the survey indicate that institutions would be willing to substitute, on average, around
52
10% of their holdings into SBBS. A high number of participants did not answer this
question.
Answer Breakdown:
1 More than 100%
1 90-100%
1 20-30%
2 10-20%
2 0-10%
8 Did not answer
1.2 Junior SBBS
In which asset class would you categorise junior SBBS?
Here we observe that many respondents have different views on senior vs junior SBBS.
Many indicated that the senior could be classified as a bond think that the junior is only a
structured product. This divergence in perception is likely to have arisen due to the
different risk profiles of the two tranches. More risk averse market participants are
hesitant to see the junior SBBS being treated like a bond (either in regulation or as an
investment opportunity), even though transparency and the look-through approach can be
applied in the same manner as in the senior SBBS.
Answer Breakdown:
3 Bond only
8 Structured product only
2 Both bond and structured product
2 Did not answer
One respondent noted that that junior SBBS could be perceived as a bond as long as
structural, regulatory and market transparency rules are satisfied (see the same question
for senior SBBS above).
There are several ways to measure credit risk. How would you score these different
risk measures in terms of their usefulness for evaluating the properties of junior
SBBS?
Very
Useful
Useful Partly
Useful
Not
Useful
No
Answer
Probability of Default 6 3 0 0 5
Expected Loss 5 4 0 0 5
Value at Risk 4 3 1 0 6
Expected Shortfall 3 3 0 0 8
Marginal Expected Shortfall 2 2 0 1 9
CoVar 2 1 2 0 9
If you have chosen “other” in question 2, above, please provide an explanation.
One respondent indicated that different risk metrics to the ones above would be very
useful: “Stress loss under extreme but plausible market conditions” and default
correlations.
53
Also one respondent indicated that “Markets would probably price this on an expected
loss basis (CDO type pricing).”
Which long-term credit rating would you expect to be assigned to junior SBBS?
7 respondents indicated a non-investment grade rating, while 8 felt the junior could get a
maximum of BBB.
What spread (in basis points) would you expect in the yield-to-maturity of 10-year
junior SBBS relative to 10-year benchmark German bunds? If possible, specify the
precise expected spread in the free text box.
A relatively high number of participants did not answer this question.
Answer Breakdown:
2 More than 300bp
3 Between 200bp and 300bp
3 Between 100bp and 200bp
1 Other: “This would depend on the credit rating achieved by, and the underlying
structure of these products.”
6 Did not answer
Any mispricing between the replicating portfolio of junior and senior SBBS and the
underlying portfolio could in principle be arbitraged away. To what extent would
you expect such arbitrage to take place?
Most respondents seemed to agree that there will be some excess spread. Its size is
debatable but the key insight here is that markets expect excess spread to exist. A
relatively high number of participants did not answer this question.
Answer Breakdown:
4 Negligible arbitrage, excess spread would be significant
5 Some arbitrage, excess spread would be small
1 Significant arbitrage, excess spread would be negligible
5 Did not answer
Would a contractual unbundling option – whereby an investor holding a replicating
portfolio of junior and senior SBBS could swap that portfolio for the underlying
sovereign bonds – facilitate arbitrage?
Respondents seem to agree that unbundling would facilitate arbitrage, albeit to varying
degrees. A relatively high number of participants did not answer this question.
Answer Breakdown:
2 Yes, unbundling option is critical for arbitrage to work
3 Yes, but arbitrage will work even without the unbundling option
2 Somewhat but other frictions would still prevent full arbitrage
1 No, unbundling option would not work, and arbitrage will be limited
7 did not answer
54
Would junior SBBS’ property of embedded leverage enhance their attractiveness in
terms of expected return?
There seems to be an agreement that the embedded leverage property of SBBS could
play a role in attracting higher demand. A high number of participants did not answer this
question.
Answer Breakdown:
2 Certainly yes
4 Probably yes
1 Maybe
8 Did not answer
Would sub-tranching junior SBBS for example in the form of a 15%-thick tranche
of equity SBBS and a 15%-thick tranche of mezzanine SBBS enhance total demand
for the securities?
Answers are consistent with market intelligence meetings, where market contacts showed
more willingness to invest in a mezzanine tranche rather than a 30% thick first loss piece.
Answer Breakdown:
2 Certainly Yes
6 Probably Yes
2 Maybe
2 Probably No
3 Did not answer
One of the “Probably no” respondents, provided further clarification for his answer.
Specifically, they believe that a mezzanine tranche could enlarge potential investors at
the detriment of the placing capabilities of the smaller and riskier junior tranche. The
only caveat to that would be to ensure that the structure is eligible for amortizing cost
under IFRS 9. Such eligibility is achieved only if there is a tranche below the bond in
question and the mezzanine bond could achieve it. They see the lack of existence of
amortising cost treatment as a non-starter for many potential buyers.
How important is the liquidity of junior SBBS?
Respondents feel that liquidity of the junior bond is important but not the same extent as
for the senior bond.
Answer Breakdown:
5 Very Important
4 Important
1 Neutral
1 Not Important
4 Did not answer
55
To ensure adequate liquidity of junior SBBS, to what extent is it important for them
to be highly standardized in a master prospectus? Or could there be some degree of
flexibility (e.g. regarding portfolio weights)?
Similar to the senior bond, there is a lot of merit in having a high degree of homogeneity
among different SBBS series. A relatively high number of participants did not answer
this question.
Answer Breakdown:
7 High standardization - the prospectus should fix portfolio weights with no scope for
deviation
2 Medium standardization - the prospectus should allow only very limited deviation
(within a small min/max range)
6 Did not answer
Why might your institution hold junior SBBS?
Responses
Asset-Liability Management
(of maturity mismatch)
0
Collateral 2 (provided it is accepted by the ECB)
Investment Return 6
Liability-driven Investment 0
Liquid store of value 1
Regulatory requirements 1
Safe store of value 1
Other reasons: Market making and hedging.
Note that MMFs and CCPs indicated that the junior bond would not be eligible for them
to hold.
Assuming that junior SBBS are designed such that they meet your requirements in
terms of credit and liquidity risk, what percentage of your institution’s current
holdings of central government debt could be replaced by junior SBBS?
Respondents mentioned very low degree of substitutability (expected given the different
nature and perception of junior SBBS relative to central government bonds). A high
number of participants did not answer this question.
Answer Breakdown:
1 10-20%
2 0-10%
2 0%
10 did not answer
What changes to the design of junior SBBS would make them more attractive?
Some participants feel that the junior SBBS does not offer enough to motivate outright
investment. The feedback received from answers to the open question was that there
must be additional buffers to protect from the high risk exposure. Some proposals are:
 “A third tranche”
56
 “Since the junior would resemble Greece (and get similar characteristics) a 5%
equity tranche placed at the ESM (with partial corresponding reduction of the Greece
program) should be introduced.”
 “Public issuance and guarantee”
 “Overcollateralization”
 “Ensure bullet nominal structure by
o an exact matching of capital redemption for bond constituents and SBBS
Notes
o a similar timing for the issuance of the SBBS and the bond constituents
 Also a Fixed rate bond requires a good certainty of coupon payments. If the bonds
are paying different coupons at different payment dates, best would be to have a
small coupon to ensure good coupon coverage and certainty, with a mechanism to
deal with excess spread, and some adjustment of the issue price to adjust the junior
SBBS yield.”
1.3 Regulation
What areas of regulation currently disincentivise the development of SBBS?
Explain your answer in the free text field.
Yes Comments
Capital Regulation for banks 5 “0% risk weight necessary”
“Large Exposure Limits, Leverage Ratio, Capital
Requirements”
“they are a structured product”
Liquidity Regulation for banks 5 “HQLA eligibility is key for banks”
“LCR”
“Would need 100% liquidity against them”
“SBBS should be LCR eligible”
Insurance regulation 2 “Solvency 2“
Investment fund regulation 1
Pension fund regulation 1
Capital bank collateral
eligibility
3 “Eligibility as collateral by the ECB is key for banks”
“SBBS should be an eligible asset with a haircut
corresponding to its reduced risk”
Other 3 “all regulation types should adjust to these instruments for
acceptance as collateral or 'safe assets’”
“Index rules and guidelines”
“individual sovereign risks can be accessed through present
markets. little value in bundling risks without sharing them.”
Other Comments:
 “We do not support a change in the current banking regulation for sovereign
exposures. Nevertheless, we consider that the success of Senior SBBS would
somehow be linked to this regulatory change in the underlying assets.”
 “Solvency capital requirements for banks and insurance holding the SBBS should be
similar to those of govies: no capital charge, no securitisation treatment, no
concentration risk.”
57
In your opinion, in the regulatory framework, should SBBS be treated according to:
This result confirms the work of Workstream B of the task force, which is operating
according to the look-through approach. It is also in accordance with the feedback
received in meetings, where participants felt that it would be unfair to SBBS if the look-
through approach was not applied. Answers to the question are strongly in favour of the
look-through approach:
Answer Breakdown:
10 Look-through approach (two emphasized that it should get 0% rw even with a
possible introduction of RTSE)
3 Current regulation on securitised products
2 did not answer
How should voting rights be allocated?
Respondents concluded that voting rights should be allocated according to investors’
holdings. A high number of participants did not answer this question.
Answer Breakdown:
3 Voting rights should be transferred to investors in proportion to their holdings of junior
and senior SBBS
1 Voting rights should be transferred to investors in proportion to their holdings of senior
SBBS
1 Voting rights should be concentrated in the special vehicle
10 did not answer
1 respondent commented that “a trustee should handle the voting rights and represent the
Noteholders.”
What other considerations should inform the design of a regulatory framework for
SBBS?
Answers:
 “EMIR regulation change to allow recognition of full portfolio margining benefits on
SBBS.”
 “A guaranteed repo market or liquidity provider available to exchange SBBS for
cash to post as collateral for variation margin under centrally cleared swaps would be
highly important to us.”
 “If they are anything other than pari-passu with governments from a regulatory
perspective the project will not work. Likely there will have to be a relative
advantage to hold them, to encourage the market initially.”
 “The success of ESBies is conditional to its regulatory treatment in banking,
insurance and pension funds regulation. For ESBies, an special treatment should be
granted in the following areas:
o Credit risk: ESBies should not follow the current regulation for securitized
products. Instead, they should receive a 0% risk weight that reflects their
condition as a risk-free asset.
o Liquidity risk: ESBies need to be recognized as a High Level Liquid Asset, so
that they are eligible to comply with the Liquidity Coverage Ratio.
58
o Market risk: In line with credit and liquidity risk, ESBies should also keep the
preferential treatment that now is granted for national sovereign debt.
o Moreover, and to reflect the own nature of ESBies as a diversified asset, they
should be exempted from the large exposure limit.
o Finally, it is also necessary that they are recognized by the ECB as collateral for
monetary policy operations and also by Central Counterparties in market
operations.
It is necessary to consider that the previous regulatory adjustment would need a
greater one, which is the change of the current regulatory treatment of the
underlying assets, that is to say national sovereign exposures. This potential
change would come with great challenges itself and should be designed and
implemented globally, to avoid creating an un-levelled playing field across
jurisdictions.”
1.4 Economics of SBBS issuance
What are the reasons for the current non-existence of sovereign bond-backed
securities?
Both the task force and feedback from the market intelligence meetings stressed that
regulation has been the main impediment. Even though respondents seem to agree with
that, it is interesting to note that they have also cited various other reasons that have not
been considered so far.
Answer Breakdown:
1 The regulation of both sovereign bonds and securitised products
6 The regulation of securitised products
1 The regulation of sovereign bonds
5 Did not answer
5 Other citations:
 Structuring costs
 Warehousing and execution risks
 High degree of complexity
 2 people felt that the sum of its parts has little to offer compared to the individual
components
 1 indicated that “Until now there was not a perceived market shortage of low-risk
and highly liquid assets, so there was no need of SBBS under the current regulatory
framework.”
What would be the most significant operational fixed and variable costs related to
SBBS issuance?
Yes
Special servicer fees 2
Trading costs 2
Credit rating fees 2
Legal costs 2
Administrative costs 2
Costs related to funding the warehouse 2
59
Other comments:
 capital cost / balance sheet use (ROE)
 regulatory burden of holding
 similar to that of ETF(those above + observability)
It is interesting to note that one respondent believes that “Issuance costs (rating, servicer,
administrative, legal costs) are probably minimal given the size expected”.
Would it be most practicable for assembly of the underlying portfolio to take place
via purchases of central government bonds on the primary markets, purchases on
the secondary markets, or by using existing portfolios?
We observe a very interesting conclusion here. Respondents did not feel that the primary
market is a necessary condition for successful issuance. This is contrary to the suggestion
in the Industry Seminar that DMO coordination would be vital (or the best solution
operationally) for the success of the issuance process.
Answer Breakdown:
7 New purchases from the primary market
3 New purchases from the secondary market
3 Use existing portfolios
3 cannot know
2 did not answer
One respondent noted that the secondary market could be used to recycle the bonds the
Eurosystem already holds.
Given the current characteristics of primary and secondary government bond
markets, would it be feasible to assemble the underlying portfolio and place all of
the corresponding senior and junior SBBS within one week, using all available
technical devices (e.g. advanced book-building)?
Of those that answered most feel that it would be possible. This implies may not be a big
impediment for an issuer to overcome. A relatively high number of participants did not
answer this question.
Answer Breakdown:
1 Yes
3 Probably Yes
2 Probably not
3 Cannot Know
6 did not answer
It is worth noting that none of those who answered “Probably Not” feel that warehousing
is a significant cost. Of the 2 people who answered “Cannot Know”, 1 thinks that such
cost would be recouped by revenues but the other believes that warehousing is a Very
Significant cost.
To what extent would coordinated DMO issuance in the primary market help to
alleviate this warehousing problem?
Respondents agree that DMO coordination would help in alleviation of the warehousing
problem. A high number of participants did not answer this question.
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Answer Breakdown:
3 Significant Alleviation
2 Partial Alleviation
1 Not relevant or necessary, as the warehousing problem is anyway minimal
9 did not answer
In view of the likely fixed and variable cost structure of SBBS issuance, how many
different SBBS issuers do you expect that the market could sustain in equilibrium?
Respondents do not feel that there is enough room in the market for many issuers. A high
number of participants did not answer this question.
Answer Breakdown:
2 2-5 issuers
5 1 issuer
8 Did not answer
Could SBBS issuance be a profitable operation? Explain your answer in the free
text field.
Most respondents could not give a definitive answer, but some positive feedback was
received. It is interesting to look at the comments provided in the free text field, as 4
respondents feel that SBBS issuance would be a profitable operation provided that
certain preconditions are met.
Answer Breakdown:
2 Yes (“The consolidated yield of SBBS could in the end become more attractive than
the yield combination of the underlying components, provided the product structuring is
made in a way to drive the market to consider those products as standalone credits rather
than structured products (hence 1 single public issuing entity, high standardization, large
volumes by issue (benchmark+taps), dedicated DMO issues to avoid duration mismatch
costs, warehousing costs, complexity, and capacity to build exact same portfolio for
arbitrages.”)
2 Probably Yes (“trading spreads and short term funding profits of unsold bonds”)
6 Cannot Know
5 Did not answer
Who should arrange and service the special vehicle?
Respondents are clearly in favour of a public entity issuing SBBS. This result is very
much in line with feedback in other fora, where investors have stated that they would
prefer some form of public guarantee. Even if the SBBS are in the balance sheet of a
privately owned institution, any involvement of a public entity would provide assurance.
Answer Breakdown:
9 Public Sector entity
1 Public-private entity
5 Did not answer
61
Insofar as the special vehicle is arrange by private-sector entities, would these
private-sector entities necessarily be primary dealers on sovereign debt markets, or
could other types of entities do the job?
Respondents seem to agree that primary dealers should be arranging the SBBS issuing
entity. A high number of participants did not answer this question.
Answer Breakdown:
5 Yes - primary dealers have a natural advantage in arranging SBBS vehicles.
2 No - SBBS vehicles could be arrange by other financial institutions as well as (or
instead of) primary dealers
8 Did not answer
Would your institution consider becoming an SBBS issuer?
Most of the institutions that answered the survey do not have any experience as primary
dealers so it is unlikely that they would ever engage in SBBS issuance. Those institutions
that would consider issuing would do so only if there were considerable regulatory
sponsorship and enough demand. One respondent stated that their institution would only
consider being an arranger and not an issuer.
Answer Breakdown:
1 Yes
7 No
3 Under Certain conditions
4 Did not answer
One respondent indicated that they would consider being market makers of SBBS.
What changes in the regulatory or market environment would make SBBS issuance
more attractive?
Most of the responses hinted to the importance of changing the regulatory regime.
Specific comments can be seen below:
 “Promote them above ordinary derivatives through regulation.”
 “Lower regulatory capital cost.”
 “Pari - passu or better ranking vs euro area government bonds”
 “Look through acceptability, not considered as securitisation”
 “As stated before, we consider that the success of Senior SBBS is conditional to their
regulatory treatment (they should receive a beneficial treatment in terms of credit,
market and liquidity risk and in terms of large exposures limits) and to the regulatory
treatment of the underlying assets. Moreover, they should be recognised by the ECB
as collateral for monetary policy operations and also by Central Counterparties for
market operations. Nevertheless, we consider it key that any changes need to be
implemented at one time. Europe cannot afford to be stuck half-way of the
implementation process of such a change.”
 “Change in the design of the risk, effective liquidity in the market for SBBS which
suppose there is a real need for this product among the investors.”
 “Arbitrage free haircuts of SBBS and bond constituents, similar liquidity of SBBS
and constituents”
62
What do you expect to be the likely impact of SBBS on market conditions for
sovereign bonds?
This is an open question and a single conclusion cannot be drawn. There were mixed
responses, with many assuming a negative impact. All the answers are illustrated below.
 “It depends on their popularity and demand. I am sceptical that they will become a
large portion of the market.”
 “Less sovereign bonds direct issuance”
 “Less supply, but also less demand, possibly leading to difficulty establishing a
liquid curve for some issuers.”
 “Negative impact on spreads and liquidity on some of the underlying sovereign
bonds.”
 “In theory if they are successful then government bond liquidity will decline as more
bonds go into SBBS. Market determination of intra-EMU spreads will be challenging
as they will reflect liquidity more than fundamentals.”
 “With the introduction of SBBS as a new asset class the current void in the middle of
the European sovereign debt market spectrum would be filled.”
 “Very limited, if issuance came from publicly held debt”
 “If successful, they would extract attractive reserve assets but may reduce liquidity in
individual country Eurozone bonds.”
 “We think that It is likely that for some countries, the expected sovereign issuances
are higher than their participation in ESBies, leaving a remaining pool of national
debt in national sovereign markets. The implicit reduction of these markets will have
significant negative consequences for sovereign debt not included in the pool for
ESBies. These bonds will face a sharp decrease in its liquidity, increasing liquidity
the premia and negatively affecting the operations in these markets, with increased
transaction costs. A solution needs to be foreseen for this type of situations.”
 “It really depends on the SBBS reaching the level where they are liquid.”
 “The SBBS would contribute to the emergence of an harmonised EU sovereign bond
market, with some mutualisation achieved through structural features rather than
policy making.”
2. SUMMARY OF THE INDUSTRY WORKSHOP49
On 9 December 2016, the ESRB held an industry workshop on Sovereign Bond-Backed
Securities (SBBS), hosted by the Banque de France. The purpose of the workshop was
to discuss the feasibility of creating a market for SBBS. Discussions were held under
Chatham House rules. This summary of proceedings is intended to capture in
anonymised form the main insights emerging from each session.
The workshop revealed a broad diversity of views with respect to SBBS’ feasibility.
Overall, participants underlined the necessity for deeper financial integration in Europe.
There was a mix of views as to whether SBBS represent the correct product with which
to achieve deeper integration: some participants expressed fundamental scepticism,
while some others thought that a functioning market for the securities could develop
under certain conditions. The discussions delivered a set of useful insights to inform the
49
This summary was prepared by staff of the ESRB's Secretariat.
63
ongoing work of the ESRB High-Level Task Force, which currently has an open mind
with respect to all aspects of security design.
Several participants in the ESRB industry workshop referred to ESRB Working Paper
no.21 in their remarks. They saw it as a natural reference point, since the working paper
represents the original inspiration behind the creation of ESRB High-Level Task Force
on Safe Assets. However, the task force is not an intellectual prisoner to the working
paper. In several ways, internal thinking in the task force has diverged from the working
paper, following policy discussions. For example, the task force envisages a
considerably smaller size of the SBBS market than is suggested in the working paper.
Insights from the workshop will allow the task force to further develop and enrich the
basic idea of Sovereign Bond-Backed Securities.
Session 1: Motivation
Session participants defined “safe” in terms of low liquidity risk, low volatility risk and
low default risk. “Safety” is therefore a relative concept along these three dimensions.
One participant emphasised the importance of low liquidity risk and low volatility risk in
(the creation of) “safe assets”: while important, low default risk was second-order, in
their view. This implies that an SBBS market should be liquid first and foremost. Two
participants agreed that a liquid SBBS market could be achieved by announcing a
calendar of regular issuance, such that market players would have a reasonable
expectation of large volume in steady-state. In addition, SBBS’ design should be as
simple as possible, such that even relatively unsophisticated investors would be
comfortable trading and holding them. Corresponding repo and futures markets would
also need to be developed to ensure liquidity. One participant emphasised the importance
of the securities’ inclusion in benchmark indices.
One participant pointed to the role of (Senior) SBBS in generating a euro area wide
benchmark risk-free rate curve. At present, many market players use national curves for
discounting. This exacerbates financial fragmentation, particularly in an environment in
which cross-country spreads are high. Moreover, a full term-structure of maturities would
help to boost SBBS’ market liquidity.
One expressed scepticism regarding safe asset scarcity, but also emphasised that
Eurobonds, embedding joint liability among nation-states, would be preferable to SBBS.
In their view, “synthetic Eurobonds” (i.e. SBBS) without joint liability may pose a
problem for certain investors reluctant to hold structured products. Moreover, the
creation of SBBS may send a (negative) signal to markets regarding the limits of
European ambition. There is also a communication challenge related to the proposed new
treatment of simple and transparent securitizations and its interaction with a policy
announcement pertaining to the creation of an SBBS market. On the other hand, a
successful SBBS market could help to revive the broader European securitization market.
Nevertheless, the issuance of a new securitization product is seen as challenging in view
of these instruments’ history over the financial crisis.
Participants broadly agreed that an SBBS market would need initiation by the public
sector, including via:
64
 DMO coordination: DMOs could coordinate issuance for the fraction of their
calendar that is intended for SBBS.
 Regulatory treatment: A necessary condition for the creation of an SBBS market
would be the application of a “look-through approach” to the regulatory treatment of
SBBS, such that they would be treated consistently with the underlying sovereign
bonds. Without consistency of treatment, would-be investors would (be forced to)
treat SBBS as structured products, both in terms of regulation and with respect to
their investment mandates, thereby shrinking the investor base. For one participant,
a regulatory treatment of sovereign bonds that imposed soft or hard concentration
charges would encourage marginal portfolio shifts in favour of SBBS. This was
deemed preferable to risk-based capital charges.
 Simplicity: SBBS should share the characteristics of straightforward fixed income
securities. A simple structure – with fixed portfolio weights on the asset side, and a
maximum of three tranches on the liability side – would encourage investors to view
SBBS as a bond rather than as a structured product.
 Liquidity: The SBBS market should be liquid, including in the build-up phase, when
volumes are below those in steady-state. Liquidity would be supported by a
transparent timetable of SBBS issues, such that investors would have a reasonable
expectation of adequate volumes.
 Clear restructuring procedures: Investors need clarity regarding the work-out
procedure in the event of a (selective) sovereign default.
Session 2: Sovereign debt markets
Session 2 participants emphasised the importance of DMOs’ objective of minimizing
borrowing costs to the taxpayer. Part of these costs is due to the liquidity premia paid by
DMOs. It is therefore important to minimize liquidity premia by ensuring continued
liquidity in existing sovereign debt markets. The SBBS market should therefore be
designed in a way that does not impair liquidity in underlying sovereign debt markets.
Although one participant emphasized that SBBS would harm price discovery on
sovereign debt markets, most thought that a gradual (rather than rapid) development of an
SBBS market – initially in “experimental” or “proof of concept” fashion – would be the
least disruptive. Gradual development would allow market players and regulators to learn
about the impact on secondary market liquidity and to calibrate the program
accordingly.50
At the same time, Session 2 participants reiterated the main insight of Session 1
regarding the importance of ensuring SBBS market liquidity. This could be compatible
with a slow, experimental approach to market development if investors were to harbour
reasonable expectations regarding the steady-state size of the SBBS market. With a
transparent calendar of regular and moderately sized issuances, several participants
50
In another session, a workshop participant noted that a fraction of the underlying portfolio could be used in
repo transactions. This could generate income for the SPV arranger – thereby encouraging new entrants to
capture such expected profits – and alleviate collateral scarcity in sovereign bond markets. As such, this
proposal could alleviate concerns regarding the impact on secondary market liquidity.
65
expressed confidence that adequate SBBS market liquidity would emerge, aided by the
development of functioning repo and futures markets.
Some participants expressed reluctance to build a regulatory treatment that would be
attractive for SBBS while penalising existing sovereign debt.
Participants thought that the most feasible way to gradually introduce an SBBS market
would be for DMOs to coordinate issuance on the fraction that is intended for SBBS, for
example by pre-agreeing to execute a (private) placement of their bonds with an SBBS-
issuing entity. Moreover, bonds would ideally be homogenous in terms of their
characteristics (e.g. maturity, coupon), thereby ensuring commonality of cash flows to
the SBBS-issuing entity over its lifetime. Most bonds would continue to be sold using the
existing mix of placements, syndications and auctions; the current market microstructure
would therefore persist, thereby limiting the effect of SBBS on secondary market
liquidity, and ensuring DMO autonomy with respect to the timing and characteristics of
the (vast) majority of their issuance calendar.
With regard to market making activities, one participant said that market making for the
senior tranche might be possible, while market making in the junior tranche would be
more difficult. Moreover, the profitability for market makers might be lower in the SBBS
market than on current national sovereign debt markets.
Session 3: Commercial banks
As in earlier sessions, several participants expressed scepticism regarding a regulatory
regime that would impose risk-based capital charges on sovereign debt. Instead,
participants favoured incentives for diversification to alleviate banks’ current home bias.
SBBS could represent such an incentive for diversification, particularly if coupled with
soft charges for concentrated portfolios. At the same time, for some participants such a
home bias is a rational behaviour, aiming at minimising asset-liability mismatches.
In general, participants expected that the yield on Senior SBBS would have a positive
spread with respect to comparable German bunds, particularly in the early stages of the
market when liquidity would be at its thinnest. One participant said that the Senior SBBS
yield would most likely be somewhere between the German bund yield and ESM bond
yield.
Several Session 3 participants emphasised the attractiveness of the broad asset class of
supranational and sub-sovereign debt, which offers moderate pick-up in terms of yield
for the same regulatory treatment as central government bonds. SBBS could tap into this
existing investor base, conditional on regulatory changes that would carve-out SBBS
from the existing treatment of structured products. An analogy is provided by covered
bonds, for which the existence of strong national laws ensures low spreads. On the other
hand, one participant thought that a consistent treatment of SBBS relative to the
underlying would be insufficient to engineer demand for SBBS. Banks in core countries
would still be reluctant to rebalance their portfolios towards Senior SBBS (owing to
worries regarding redenomination risk), whereas banks in vulnerable countries would be
reluctant to forego the high returns expected from holding domestic sovereign debt. In
their view, regulators would need to implement a favourable treatment of SBBS (relative
66
to the underlying), but this would have the undesirable side effect of crowding-out
demand for the remaining float of national debt.
Several participants argued that the proposed calibration for the junior tranche (30%)
would be too high relative to the size of the potential investor market. In this respect,
sub-tranching would reduce the size of the high-yield first-loss piece that would need to
be placed with investors but would add to the complexity of the product.
One participant highlighted a dilemma whereby – on the one hand – SBBS issuance
entails a natural monopoly, but public-sector issuance of SBBS would entail implicit
risk-sharing among nation-states. Overcoming this dilemma would require changes to the
features of SBBS issuance that imply natural monopoly. One such change could be the
coordinated DMO issues suggested in Session 2.
Session 4: Non-bank Investors
Session 4 participants began by highlighting their reasons for holding sovereign bonds.
Several participants pointed to the role of liability-driven investment, which calls for
long-dated, fixed-income assets. For these buy-and-hold investors, liquidity is less
important; instead, what matters is low credit risk combined with non-negative returns.
Participants emphasised that the attractiveness of SBBS is a relative value proposition.
Investment decisions would be based on SBBS’ expected risk/return relative to other
investible assets.
 One participant expressed a preference for Senior (rather than Junior) SBBS,
conditional on regulatory reform that would define SBBS as sovereign bonds rather
than structured products. To be used as a duration instrument, Senior SBBS would
ideally need to be rated AAA, with a moderate pick-up compared with other AAA-
rated assets. Transactions costs for trading SBBS would also need to be low.
 Another participant claimed that risk managers would treat SBBS as a securitization,
regardless of the existence of regulation that may define it otherwise. This could
impede the extent to which Senior SBBS could be used to manage duration risk.
 Another participant claimed that redenomination risk should be taken into account
because it influences ratings and pricing.
 A third participant said that they may hold Junior SBBS in (relatively niche) funds
that permit holdings of structured products. In their view, Senior SBBS would only
be held by sovereign bond funds if they were to comprise part of the benchmark
against which performance is evaluated. In general, holding Senior SBBS in a
sovereign bond fund would be difficult or impossible in the absence of changes to
the mandates of such funds that otherwise prohibit holdings of structured products.
This would require investors to perceive SBBS as a non-securitised product.
 Two participants claimed that the “maths don’t add up” in terms of the likely yield
on Senior and Junior SBBS relative to the underlying. In their view, prospective
holders of Junior SBBS would require a very high return, such that the Senior SBBS
yield would be negative in the current environment.
67
Session 5: Demand for junior SBBS
Session participants agreed that regulatory change would be necessary to ensure the
success of an SBBS market – echoing earlier contributions. One participant noted that –
even with regulatory reform – holders of SBBS would continue to bear “regulatory risk”
(as the future framework could again be changed to penalize SBBS, just as recent
reforms have penalized ABS).
Participants discussed the size of the potential investor base for Junior SBBS. One
participant said that Junior SBBS represents “high octane” sovereign risk, and would
therefore compare naturally to emerging market sovereign debt. There is an investor base
for such risk exposure, but it is relatively niche. Another participant said that investors
would evaluate the relative attractiveness (in terms of risk/return) of Junior SBBS
compared with (high-yield) corporate bonds. This suggests finite investor capacity for
high-yield debt instruments. As such, there may be a natural limit on the size of the
SBBS market. The point at which this limit is reached could be identified by a step-by-
step approach to growth in the SBBS market.
Several participants expressed concerns regarding high correlations between the
underlying sovereign bonds’ probabilities of default. The unconditional probability of
sovereigns’ default is lower than the default probability conditional on the default of
(other) sovereigns. Modelling such conditional probabilities is difficult, however, and
subject to considerable parameter uncertainty. Before the crisis, the market had amassed
a rich stock of expertise capable of pricing such securities in the presence of parameter
uncertainty. While this expertise has now atrophied, it could be revived by an active
SBBS market.
One participant noted that collateralized debt obligations require a positive arbitrage
margin in order to generate profits. Some prospective CDOs generate a negative arbitrage
margin, and do not function for that reason. The same challenge applies to SBBS. To
maximize the probability of a positive arbitrage margin, SBBS issuer(s) could engage in
“ratings optimization” with respect to the tranches. This suggests that at least three
tranches would be warranted (namely first-loss, mezzanine and senior). Such investor
catering could be done by the market via “re-securitizations”, conditional on regulatory
reform to accommodate SBBS2
as well as SBBS.
One participant argued that SBBS could increase the probabilities of sovereigns’ defaults
in equilibrium. Default would be less costly insofar as banks rebalance their sovereign
portfolios away from their current home-biased holdings in favour of Senior SBBS. This
changes sovereigns’ cost/benefit calculation, as a default would be less destructive for the
domestic banking sector and therefore for the functioning of the real economy. At the
margin, then, widespread holdings of Senior SBBS in the banking sector could make
sovereign default more likely.
Session 6: Risk measurement
All participants took a generally conservative approach to SBBS’ risk measurement. In
terms of credit risk, this implies an underlying assumption of high correlations during
stress events. In terms of liquidity risk, this implies a working assumption of low
liquidity until proven otherwise.
68
Several participants noted that correlation among underlying sovereign bonds’ default
probabilities is important for measuring SBBS’ risk but difficult to quantify. A
conservative approach would assume high correlations, particularly during crisis
episodes. Very high correlations would imply that the Senior SBBS would struggle to
achieve a top rating with 30% subordination, particularly given that the underlying
portfolio is “lumpy” as it is comprised of just 19 sovereigns (so that discrete default
events have large effects).
One participant noted that the probability of default of the Junior SBBS would be at least
as high as the highest probability of default in the underlying portfolio. Some credit
ratings take expected recovery rates into account, such that Junior SBBS could benefit
from a better rating than implied by its probability of default, but it was noted that
recovery rates are subject to a high degree of uncertainty. Another participant emphasised
the importance of achieving clarity ex ante on the work-out arrangements for Junior
SBBS in the event of a default on the underlying bonds.
3. MAIN TAKEAWAYS OF THE CLOSED-DOOR DMO WORKSHOP
The HLTF organised a closed-door workshop with DMOs on 20 October 2017 in Dublin.
The workshop intended to offer DMOs an opportunity to express their views on the
SBBS proposal and to seek their expertise on specific (technical) issues.
DMOs raised concerns regarding the design and implementation of SBBS and
highlighted that, in their view, SBBS would not be the appropriate tool to break the bank-
sovereign nexus nor to implement a euro area low-risk asset. More specifically, DMO's
concerns related to the impact on national sovereign bond markets (in particular
liquidity), the implications of primary and/or secondary market sovereign bond purchases
by SBBS issuers, and the possible regulatory treatment of SBBS.
On sovereign bond market liquidity: DMOs stressed that liquidity and transparency on
a marketable volume of debt are a prerequisite for a well-functioning market. Thus,
SBBS would need to be issued in a sizeable amount (up to EUR 2 trillion) in order to be
accepted and bought by investors. This, however, could have a negative impact on the
remaining national sovereign debt markets (reducing liquidity, increasing refinancing
costs, in particular for small and medium sized sovereign debt markets).
On primary and secondary market purchases by the SBBS issuer: The HLTF
considered both secondary and primary market purchases (including dedicated issuances)
as ways for SBBS issuers to build their underlying sovereign bond portfolios. DMOs
stated that either option would cause problems for sovereign issuers, as they would
disrupt market functioning. Further, both options would require a risk-taking treasury
function for SBBS issuers, which—in case of a public issuer—could give rise to
mutualisation of risks. Regarding the proposal for dedicated issuances, DMOs stressed
that it would violate their legal obligations not to offer preferential access and would
have a negative impact on the functioning of sovereign debt markets, notably on market
access, debt rollover in each country, and price formation disruptions.
On the regulatory treatment of SBBS: DMOs highlighted that any regulatory
intervention should not include privileges for SBBS compared to the underlying
sovereign bonds, as this would lead to higher funding costs for sovereigns. They
questioned whether, without regulatory privileges SBBS could ever become viable.
69
ANNEX 3 WHO IS AFFECTED AND HOW?
1. PRACTICAL IMPLICATIONS OF THE INITIATIVE
This annex assesses the different impacts of the identified policy options (models) on the
main stakeholders, as well as on the aggregate financial sector. The key stakeholders that
would be affected by the proposed legislation include banks (and other financial
institutions subject to CRR/CRD), other asset managers, the arrangers/issuers of the
product, supervisors, and debt management officers (as proxies for the effect of the
legislation and of SBBS on the national sovereign debt markets).
The impact, both in terms of potential benefits and potential costs, would depend on the
size ultimately achieved by the market. Since the proposed intervention is an enabling
legislation, and considering that the product to be enabled does not currently exist,
whether or not the market for such product will take off or to what extent is difficult to
predict with certainty. Nevertheless some general considerations can be offered to help
gauge the legislation's possible ultimate impacts, and the channels through which these
would come about. The general costs and benefits, irrespective of the specific option or
scenario considered, are summarised in Table 5 and Table 6, respectively. Table 7 and
Table 8 summarise the possible impact more specifically per stakeholder and respectively
for a scenario in which the enabled product reaches only a limited size, and one in which
instead the product reaches a macro-economically significant size (steady state
scenario)51
. Lastly, Table 9 focusses specifically on the compliance costs for
stakeholders.
51
For example, either EUR 500 billion, which the HLTF report currently envisages could be reached within 10
years, or EUR 1,500 billion, which the HLTF considers as the steady state size of the market, taking into
account constraints which are necessary to safeguard market functioning and price formation.
70
Table 5: Overview of the benefits
I. Overview of Benefits (total for all provisions)
Description Amount Comments
Direct benefits
Eliminated
regulatory
surcharges
#NA.
Capital requirements: At present, holding SBBS would be
associated with positive capital requirements. The proposed
legislation would either completely eliminate these (models 1 and
5) or eliminate them for senior tranches (model 2).
Liquidity coverage requirements: banks would be able use these
new products to meet liquidity coverage requirements, which is
not possible under the current regulatory framework.
These benefits would increase with the market size of the new
instrument. Some indicative calculations to gauge the economic
significance of these benefits are provided in Annex 4.
A new product
becomes available
#NA. A new instrument would become available for banks, insurance
companies, pension funds and other investors. Two scenarios
have been analysed. A "limited" scenario, in which SBBS
develop very gradually and reach a limited volume
(EUR 100 billion) and a "steady state" one where SBBS reach a
macroeconomically significant volume (EUR 1,500 billion).
The actual size of the SBBS market will depend on the
instruments' overall attractiveness for market participants.
A more stable
financial system
#NA. A quantitative assessment is difficult, because of the significant
uncertainty on the extent to which the market would develop.
Nevertheless, from a qualitative perspective, the new instrument
could contribute to financial system stability at large as it would
weaken the bank-sovereign loop. Further, as a share of the
outstanding sovereign bonds would be held in SBBS portfolios,
these bonds would not be quickly sold off in times of financial
market stress.
Expand the
investor base for
European
sovereign debt
#NA. A quantitative assessment is difficult, because of the significant
uncertainty on the extent to which the market would develop.
Nevertheless, from a qualitative perspective, benefits could be
large. In particular for smaller Member States whose sovereign
bonds may not be on the radar screen of investors, demand
coming from the SBBS issuer would facilitate Debt Management
Offices debt placements.
Indirect benefits
Indirect benefits
on retail investors,
households or
SMEs
#NA. These sectors do not benefit directly as they are unlikely to be
active in the SBBS market. They might benefit indirectly –
including from enhanced confidence and lower borrowing costs –
to the extent that the above-mentioned benefits in terms of
enhanced financial stability materialise.
71
Table 6: Overview of the costs
II. Overview of costs
Citizens/Consumers Businesses Administrations
One-off Recurrent One-off Recurrent One-off Recurrent
For all
considered
models
Direct
costs
None None None for
SMEs and
other Non-
Financial
Corporations
For issuers of
the new
product, see
Table 9
None for
SMEs and
other Non-
Financial
Corporations
For issuers of
the new
product, see
Table 9
Creation of
a new
legislation
Supervision
of SBBS
(depending
on the
model, these
costs range
between
limited and
moderate)
Indirect
costs
None If the
introduction of
SBBS were to
impact sovereign
bond market
liquidity, this
could lead to
higher financing
costs for Debt
Management
Offices, which
would in the end
be carried by the
tax-payer. The
analysis
conducted by the
HLTF suggests
that any such
costs would be
limited (see also
Annex 4.3)
None None None None
In general terms, the enabled product would entail the following benefits: eliminate
unjustified regulatory surcharges which allows for the development of a market of a new
instrument, lead to a more stable financial system and expand the investor base for
national sovereign bonds (see Table 5). On the contrary, the costs for citizens, businesses
and administrations appear to be limited (see Table 6).
More specifically (see Table 7 and Table 8), as regards banks and other financial
institutions subject to CRR/CRD, under all models the proposed legislation would have a
positive (or, in the limit, neutral) impact in both scenarios. The legislation could unlock
the assembling and use of new financial products, all of which could—to varying
degree—potentially be used by banks to enhance their risk management.52
With the first
two models, which would ensure greater standardisation in these new markets, banks
may have greater incentives to invest, because the new products would have many of the
features of the benchmark government bonds that banks currently invest in, at least from
52
See Annex 4, section 5 for some calculations on the impact of the introduction of SBBS on banks' sovereign
portfolios under both the limited volume scenario and the steady state scenario.
72
a regulatory perspective.53
Model 1 is the most favourable for the banks (under both
scenarios), because besides gaining access to a potentially liquid product, they would be
able to invest in all of its tranches without facing additional capital charges or liquidity
discounts.54
In contrast, with model 2, banks would have an incentive to buy only senior
tranches.55
As regards the issuers/arrangers, under all models the proposed legislation would have a
positive (or, in the limit, neutral) impact in both scenarios. The impact overall crucially
depends on whether the product would be profitable to arrange or not. Again, model 1
seems to be the most favourable for arrangers in both scenarios.
When it comes to the supervisors the impact under the different policy options crucially
depends on the market infrastructure. It is impossible to predict the impact ex ante. While
the impact would be positive if the product enhances stability of the overall financial
system through more diversified banks (most likely under models 1 and 2), some policy
options might increase the costs for supervisors given the non-standardisation and
different regulatory treatment of the tranches (e.g. model 4).
The impact on DMO's depends mainly on the market size of the new product (limited
volume scenario vs steady state scenario; but also models 1/2 vs. models 3/4) and the size
of the national sovereign bond market. Especially Member States with low debt levels
might be affected more markedly. Under the steady state scenario, large amounts of
SBBS would reduce the amounts of sovereign bonds floating on the market. This could,
for some Member States, result in lower trading and lower liquidity. Under the limited
volume scenario (any such negative impact would be limited.56
At the same time, the fact
that national bonds are bound in the SBBS portfolio/basket, contributes to greater support
in time of volatility, as bonds in the SBBBS structures/basket would not be sold off. To
the extent that SBBS would make the overall financial system more resilient, they could
also help lowering sovereign funding costs.
Regarding compliance costs, only the costs associated with the preferred compliance
setup (that is, option 3.1—self attestation) are assessed. Those are based on the following
actions, which need to be undertaken by different stakeholders for the issuance and
distribution of the new product (we consider in what follows only models 1,2 and 3, i.e.
those for which issuers have to assemble a pre-determined portfolio of euro area
sovereign bonds (in line with the ECB key):
Action 1: Debt issuance by DMO
53
For example, in models 1 and 3, all tranches would be made fully eligible for liquidity-related requirements—
even though as new products the extent to which they would be liquid in practice is unknown a priori.
54
Depending on the demand for bank loans, the extent to which any investment into these tranches would be an
addition to a bank's existing sovereign portfolio or rather a reshuffling of the latter may vary. For example, if
demand (and profitability) of bank loans is strong, so that investment in low-risk but also low-yielding assets
such as sovereign bonds is minimized (and possibly strictly dictated by regulatory requirements), it is likely
that banks would switch their existing sovereign portfolios into these new products, if they purchase the latter
at all. In contrast, in a situation where banks have excess liquidity, it is possible that they might decide to add
to their existing sovereign exposures via these new products.
55
The same logic applies to models 3 and 4.
56
See Annex 4, section 3 for an analysis of the impact of SBBS on national sovereign bond markets, in particular
liquidity.
73
Action 2: Structuration of the product by Arranger (purchase of underlying sovereign
bonds, drafting of legal documentation for the transaction (including, where relevant,
the tranching method and the payment waterfall), issuance of self-attestation)
Action 3: Potential certification (non-mandatory) by Third party
Action 4: Distribution of the SBBS by Arranger on the basis of self-attestation and
potential certification by third party
Action 5: Due diligence carried out by Investors to check the product is compliant
Action 6: Supervisory oversight of regulated investors by Supervisors
It is to be noted that those actions are not necessarily taken in a chronological order, since
for instance the pre-marketing and book building of the product can start before the
underlying sovereign bonds are issued. Similarly, distribution arrangements/agreements
can be entered into before the Arranger puts together the relevant portfolio (and issues
the tranches, if relevant).
2. SUMMARY OF COSTS AND BENEFITS
Table 5 and Table 6 summarise the costs and benefits in general terms. Table 7 and
Table 8 sketch out a summary of the costs and benefits of the five models on for different
stakeholders, first for a limited development of the product and second for the steady
state where the product reaches a macroeconomically significant size. Table 9 focusses
on the compliance costs for stakeholders, on the basis of the actions describe above.
74
Table 7: Impact Assessment Analysis, by Stakeholder Type (limited volume scenario)
Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product
achieves only a limited size.
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as euro
area sovereign bonds
Only SBBS proper;
Treat only Senior tranches
as euro area sovereign
bonds
All securitisations;
Treat all tranches as euro
area sovereign bonds
All securitisations;
Treat only Senior tranches
as euro area sovereign
bonds
Proper SBBS basket;
Treat basket as euro area
sovereign bonds
Banks
Positive.
New products become
available, with minimised
regulatory charges.
Positive.
New products become
available, with minimised
regulatory charges. Banks
would face high charges if
they invest in sub-senior
tranches. This may,
however, lead them to de-
risk.
Positive/Neutral.
Access to more products.
But products may not be
attractive if not
liquid/standardised.
Positive/Neutral.
New products become
available, some with
reduced/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Neutral.
Access to a new
standsardised product. But
product may not be
attractive from a risk-return
perspective and assets
based on the basked would
be riskier than the current
portfolios of most banks.
Other
investors
Positive/Neutral.
Some new products become
available, which may have
benchmark-like properties.
Positive/Neutral.
Some new products become
available, which may have
benchmark-like properties.
Positive/Neutral.
New products become
available, with
minimised/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Positive/Neutral.
New products become
available, with
minimised/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Neutral.
Access to a new
standsardised product. But
product may not be
attractive from a risk-return
perspective.
Arrangers
Possibly positive.
A market may develop out
of standardisation, with no
regulatory disincentives,
and it would have to be
profitable for the product to
be viable (though
competition among
potential issuers could bring
any rent down to zero).
Possibly positive.
A market may develop out
of standardisation, with no
regulatory disincentives,
and it would have to be
profitable for the product to
be viable (though
competition among
potential issuers could bring
any rent down to zero).
More challenging than
model 1 because the
potential investor base for
sub-senior tranches is more
restricted.
Neutral.
Little structure means
maximum flexibility. But
market may not develop for
lack of standardisation →
not profitable.
Neutral.
Little structure means
maximum flexibility. But
market may not develop for
lack of standardisation →
not profitable. Moreover
finding buyers for sub-
senior tranche may be more
challenging.
Neutral.
A market may develop out
of standardisation, but it
would have to be profitable
for the product to be viable.
Supervisors
Depends on market
infrastructure, but positive
if financial system is overall
more stable.
Depends on market
infrastructure, but positive
if financial system is overall
more stable.
Depends on market
infrastructure.
Depends on market
infrastructure.
May be more costly to
monitor/enforce than
model 3.
Depends on market
infrastructure.
DMOs
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Some products could
compete with some
sovereign bonds. But
effects likely to be small if
market is small.
Unclear.
Product could compete with
some sovereign bonds. But
effects likely to be small if
market is small.
75
Table 8: Impact Assessment Analysis, by Stakeholder Type (steady state scenario)
Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product
reaches a macro-economically significant size.
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as euro
area sovereign bonds
Only SBBS proper;
Treat only Senior tranches
as euro area sovereign
bonds
All securitisations;
Treat all tranches as euro
area sovereign bonds
All securitisations;
Treat only Senior tranches
as euro area sovereign
bonds
Proper SBBS basket;
Treat basket as euro area
sovereign bonds
Banks
Very positive
Additional benchmark-type
products are now available
at no/low regulatory
charges. The senior tranche,
being low risk, can be quite
effective at isolating banks
from idiosynchratic
gyrations in the price of
individual euro area
sovereign bonds.
Very positive
Additional benchmark-type
products are now available
at no/low regulatory
charges. The senior tranche,
being low risk, can be quite
effective at isolating banks
from idiosynchratic
gyrations in the price of
individual euro area
sovereign bonds. Banks
would face charges if they
held sub-senior tranches.
But this may lead them to
de-risk.
Positive/Neutral.
Access to more products.
But products may not be
attractive if not
liquid/standardised.
Positive/Neutral.
New products become
available, some with
reduced/no regulatory
charges. But products may
not be attractive if not
liquid/standardised.
Neutral.
Access to a new
standsardised product with
no regulatory charges. But
product may not be
attractive from a risk-return
perspective and assets
based on the basked would
be riskier than the current
portfolios of most banks.
Other
investors
Positive.
Additional benchmark-type
products are now available,
offering different risk-
return profiles which may
cater to different clienteles
Positive.
Additional benchmark-type
products are now available,
offering different risk-
return profiles which may
cater to different clienteles
Positive/Neutral.
New products become
available, with
minimized/no regulatory
charges. But products may
not be attractive if not
liquid/standardised
Positive/Neutral.
New products become
available, with
minimized/no regulatory
charges. But products may
not be attractive if not
liquid/standardised
Neutral.
Access to a new
standsardised product. But
product may not be
attractive from a risk-return
perspective.
Arrangers
Positive.
A new market is now
available, evidently
profitable (though
competition among
potential issuers would
bring any rent down to
zero). The new product may
attract demand which is
additional with respect to
the demand of underlying
bonds. Hence the overall
size of the industry (e.g.,
primary dealers) may be
boosted.
Positive.
A new market is now
available, evidently
profitable (though
competition among
potential issuers would
bring any rent down to
zero). The new product may
attract demand which is
additional with respect to
the demand of underlying
bonds. Hence the overall
size of the industry (e.g.,
primary dealers) may be
boosted. More challenging
than model 1 because the
potential investor base for
sub-senior tranches is more
restricted.
Positive if the market
development is all on one
or a few products only,
which then become
attractive/profitable thanks
to standardisation.
Otherwise, neutral.
Positive if the market
development is all on one
or a few products only,
which then become
attractive/profitable thanks
to standardisation.
Otherwise, neutral. Investor
base for large quantities of
sub-senior tranches may be
more challenging than
under model 3.
Neutral.
A market may develop out
of standardisation, but it
would have to be profitable
for the product to be viable.
Supervisors
Positive.
Banks are likely to be more
diversified, which makes
the financial system more
stable. This is likely to
outweigh any costs from ad-
hoc
supervision/certification/lic
ensing duties.
Positive.
Banks are likely to be more
diversified and to have
carved out the most volatile
exposures, which makes the
financial system more
stable. This is likely to
outweigh any costs from ad-
hoc
supervision/certification/lic
ensing duties.
Depends on market
infrastructure and on the
extent to which the new
products are used by
financial sector players, and
banks in particular, to
effectively reduce risks.
Depends on market
infrastructure and on the
extent to which the new
products are used by
financial sector players, and
banks in particular, to
effectively reduce risks.
Monitoring/enforcing costs
are likely to be greater than
in model 3 but so is also the
de-risking potential fior
banks.
Depends on market
infrastructure.
76
Table 8 (continued):
Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product
reaches a macro-economically significant size in the steady state.
Model 1 Model 2 Model 3 Model 4 Model 5
Only SBBS proper;
Treat all tranches as euro
area sovereign bonds
Only SBBS proper;
Treat only Senior tranches
as euro area sovereign
bonds
All securitisations;
Treat all tranches as euro
area sovereign bonds
All securitisations;
Treat only Senior tranches
as euro area sovereign
bonds
Proper SBBS basket;
Treat basket as euro area
sovereign bonds
DMOs
Unclear.
To the extent that SBBS
render the financial system
more resilient (e.g., weaken
bank-sovereign loop), they
could help lower sovereign
funding costs. Large
amounts of SBBS would
reduce the amounts of
sovereign bonds floating on
the market. In some cases
(e.g., especially for Member
States with relatively low
debt) this could result in
reduced trading/liquidity.
This would need to be
juxtapposed to any benefit
from greater support in
time of volatility, since
bonds in SBBS structures
would not be sold off.
Unclear.
To the extent that SBBS
render the financial system
more resilient (e.g., weaken
bank-sovereign loop), they
could help lower sovereign
funding costs. Big volumes
of SBBS would reduce the
amounts of sovereign bonds
floating on the market. In
some cases (e.g., esp. for
Member States with
relatively low debt) this
could lead to reduced
trading/liquidity. This
would need to be
juxtapposed to any benefit
from greater support in
time of volatility (bonds in
SBBS structures would not
be sold off). The effect of
greater banks' incentives to
offload junior tranches
depends on the elasticity of
demand for senior tranches
by banks and for all tranches
by other investors.
Unclear a priori.
"Successful" products could
compete with some
sovereign bonds. And,
depending on what these
successful products bundle
together, the liquidity on
some sovereign debt
market could be affected.
The extent to which funding
costs are lowered from
reduced "doom loop" risk is
difficult to assess a priori.
Unclear a priori.
"Successful" products could
compete with some
sovereign bonds. And,
depending on what these
successful products bundle
together, the liquidity on
some sovereign debt
market could be affected.
The extent to which funding
costs are lowered from
reduced "doom loop" risk is
difficult to assess a priori.
The effect of greater banks'
incentives to offload junior
tranches would depend on
the elasticity of demand for
senior tranches by banks
and for all tranches by other
investors.
Unclear.
The proper SBBS basket
could compete with some
sovereign bonds. Large
amounts of proper SBBS
baskets would reduce the
amounts of sovereign bonds
floating on the market. In
some cases (e.g., especially
for Member States with
relatively low debt) this
could result in reduced
trading/liquidity. This
would need to be
juxtapposed to any benefit
from greater support in
time of volatility, since
bonds in the SBBS basket
structure would not be sold
off.
77
Table 9: Overview of compliance costs, option 3.1
DMO Arranger Investor Supervisor Third party validators
Action
(1)
No compliance costs
are expected for
DMOs compare to the
baseline scenario
Some costs could
arise if DMOs have to
increase the
coordination of their
issuance activities
(e.g., issue similar
maturities at similar
times). Such
coordination is not
necessary, however,
and would
presumably be
undertaken only if
deemed worthwhile.
- - - -
Action
(2)
- Compliance relies on
arranger, however
the self-attestation
does not entail any
administrative
burden compared to
the structuration of
other products. The
ESRB HLTF
estimates upfront
costs of
EUR 1.15 million
and annual costs of
EUR 3.26 million
for an SBBS
programme of
EUR 6 billion (see
ESRB HLTF report,
section 4.1.2)
- - -
Action
(3)
- - Such costs would
ultimately need to be
borne by investors;
however since the
mechanism is not
mandatory, this would
not in any event
undermine the viability
of the product. In
addition, and as
explained in greater
detail in section 6.4,
these costs are likely to
be small, given the
limited nature of the
certification/review.
- The compliance costs
associated with non-
mandatory third party
certification would
depend on the level of
competition on this
market. These costs
are likely to be small,
given the limited
nature of the
certification/review
(basically, confirming
that the stated
sovereign bonds are
effectively in the
underlying portfolio
and in the stated
quantities).
78
Action
(4)
- No additional cost
compared to the
distribution of other
structured products
- - -
Action
(5)
- - No administrative cost
is required from
investors; regulated
investors will however
need to ensure the
product purchased
complies with
regulatory
requirements; this is
however inherent to
the activities of
regulated investors and
likely to be relatively
inexpensive, given the
pre-determined
structure of the product
and the fact that it
hinges on euro-area
sovereign bonds.
- -
Action
(6)
Supervisors will
perform their controls
as for any other assets
held by regulated
investors. This does
not entail additional
costs compared to the
baseline scenario
The preferred setup for ensuring compliance (option 3.1) does not entail any additional
cost compared to the regular conduct of business. The only potential compliance costs
may arise from the recourse to a voluntary certification by an independent third party, in
which case the costs would be ultimately borne by investors. Those costs remain
hypothetical, and their quantification would depend on a wide range of factors, such as
the market structure for such business. They are likely to be small, given the limited nature of
the certification/review (basically, confirming that the stated sovereign bonds are effectively in
the underlying portfolio and in the stated quantities). The voluntary recourse to such
mechanism ensures that it would not undermine the viability of the SBBS.
79
ANNEX 4 ANALYTICAL METHODS
This annex covers analytical assessments to provide evidence on (1) the extent of
"hindrance" faced by SBBS at present (pre-1/1/2019); (2) the extent of "hindrance" faced
by SBBS at post 1/1/2019; (3) the extent to which SBBS would impact remaining
national debt markets; (4) an estimation of the impact on the volume of AAA assets; and
(5) and estimation of the impact on the composition of banks' sovereign portfolios.
1. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT PRESENT
This annex is based on the assessment undertaken by the ESRB HLTF, presented in
section 5.5 in volume II of the report and focuses on evidence on the extent of
"regulatory hindrance" faced by SBBS under current regulations (pre-1/1/2019).
The analysis compares the impact on banks' and insurance companies' capital
requirements57
if existing sovereign exposures were replaced by senior SBBS under the
current regulatory regime.58
Analysis for banks
It compares two scenarios:
- Scenario 1 – status quo: SBBS do not exist, and banks hold their existing sovereign
bond portfolios. This is the status quo benchmark against which the alternative with
SBBS is measured.
- Scenario 2 – banks replace their entire sovereign bond portfolios by senior SBBS
under current regulatory treatment. Banks’ SBBS holdings are treated according to
current securitisation regulations (Articles 242-270 of the CRR) and receive a risk
weight of 20% for credit risk. The look-through approach would apply for the
concentration risk charge. This means that the share of each sovereign in the SBBS
(multiplied by the total holdings that are exchanged for SBBS) would be set against
the bank’s Tier 1 capital to determine whether and in which concentration bucket the
exposure to that sovereign would fall. In the case of partial substitution, this amount
would have to be added to the remaining sovereign holdings of each sovereign.
The data used comes from the EBA 2015 Transparency Exercise for end-June 2015 and
includes 105 EU banks at the highest level of consolidation. The data includes exposures
to central government, regional government and local authorities. The composition of
SBBS is assumed to include only euro area sovereign bonds. Further, it is assumed that
senior SBBS obtain a rating within credit quality step 1.
As an illustrative exercise, banks are assumed to exchange their entire portfolio of
sovereign holdings for senior SBBS. This exercise thus generates an upper bound
estimate of the additional capital requirements to which SBBS are subject in the current
57
As regards liquidity coverage requirements, banks would be able use SBBS to meet liquidity coverage
requirements, which is not possible under the current regulatory framework. This would thus constitute a
benefit which would increase with the volume of the new instrument.
58
The analysis of the ESRB HLTF is much wider and covers the impact on capital requirements under different
possible RTSE reform options.
80
regulatory framework, as less comprehensive switches would be associated with lower
associated capital requirements.59
The results are presented in Table 10. They clearly
show that the status quo would lead to a higher cost of holding SBBS versus holding the
underlying directly, given SBBS would have a high credit risk weight of 20% for senior
SBBS under current regulation (Scenario 2). This treatment to which they would be
subject under existing regulation reveals a key reason for the non-existence of SBBS.
Table 10: Capital charges for euro area sovereign exposures or senior SBBS under the two
scenarios (assuming 100% substitution)
Regulation of
(the underlying)
sovereign bonds
Scenario 1
(current sovereign bond holdings; no
SBBS)
Scenario 2
(SBBS: current securitisation
regulation, credit RW: 20%)
EUR billion As a % of
CET 1 capital
EUR billion As a % of
CET 1 capital
Status quo 0 0 70.7 5.0
Notes: Total capital needs refer to the capital banks would have to raise to keep their current CET1 capital ratio
constant.
Source: Report of the ESRB HLTF.
Analysis for insurance companies
A similar analysis has been conducted on the implications for insurance companies60
replacing their sovereign holdings with senior SBBS. Table 11 shows estimates of the
absolute and relative increase in the Solvency Capital Requirement (SCR) for euro area
solo insurance companies if they were to reinvest their current holdings of euro-
denominated sovereign bonds into senior SBBS, and if they are assumed to be treated
under current regulatory rules. These figures underline that under the existing regulatory
treatment insurance companies would have no incentive to hold SBBSs compared to
sovereign bonds.
Table 11: Increase in SCR requirements for euro area solo insurance companies
Status quo:
Treatment of
sovereign bonds
Scenario 1a:
Treatment of senior SBBS as
type 2 securitisation
Scenario 1b:
Treatment of senior SBBS as
type 1 securitisation
Increase in SCR
(EUR billions)
0 963 166
Relative increase in
SCR (%)
0 262 45
Notes: Type 1 securitisations are "high quality" securitisations, while all others are covered under type 2
securitisations.
Source: Report of the ESRB HLTF.
59
At the same time, if banks were to switch not just into senior but also sub-senior SBBS tranches, the resulting
capital requirements would actually be correspondingly larger, since sub-senior tranches under the current
regulatory framework would warrant higher risk weights than senior ones.
60
Euro area insurers hold assets of EUR 7.3 trillion. The current allocation of all euro area insurers to Euro
sovereign bonds is EUR 1.500 billion. The average duration is 8.96 years.
81
2. EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT POST 1/1/2019
As discussed in the main text, even after the entry into force of Regulation (EU)
2017/2042 on 1/1/2019, banks using standardised approach for the determination of
capital requirements would not be able to apply a full look-through (and thus benefit
from zero risk weights) to sub-senior tranches of SBBS.
To gauge the extent of this hindrance, albeit somewhat indirectly, we have calculated the
proportion of sovereign bonds which at present are assessed under the standardised
approach.
Using the granular data of the EBA 2017 transparency exercise as of 30 June 2017, we
compare for each bank in the EBA sample (133 banks) the share of government and
central bank exposures assessed under the standard method and the IRB method for
prudential purpose. We then calculate the amount of sovereign bonds hold by those
banks which mainly use the standard method.
The exercise shows that:
 98 out of 133 banks mostly use the standard approach and would thus be subject to
stiff capital requirements if they switched their sovereign holdings into the three
tranches.
 Some 37% of all sovereign bonds in the sample are currently held by those banks
which mostly use the standardised approach.
In addition, since the sample of the EBA includes the most complex banks in the EU,
which are also the most likely to use the IRB approach, our results remain conservative
and tend to underestimate the overall use of the standard method by EU banks.
Therefore the hindrance in the status quo would be rather significant. Indeed, assuming
that banks fully switch their current holdings of sovereign bonds for balanced positions
in all the three SBBS tranches (i.e., invest respectively 70% in the senior, 20% in the
mezzanine and 10% in the junior) and assuming that the mezzanine (respectively, junior)
tranche would attract a capital charge of 80% (respectively 1250%), equivalent to a
quality step 4 (respectively, 17 or higher, including not rated) in the table of Article 264
of Regulation (EU) 2017/2401 (rescaled for STS-like securitisations), aggregate risk-
weighted capital would increase by about EUR 1,675 trillion.61
Of course, this is an upper limit, and its value depends on the assumptions made
(including on the risk weights warranted by the sub-senior tranches). A more limited
switch, for example, would be associated with correspondingly lower capital charges:
assuming that the SBBS market reaches EUR 100 billion, as in the limited volume
scenario discussed in section 6.1 of the main text, and that SA banks would buy some
EUR 62 billion of this amount (in line with their current shares of government bonds in
the overall banking book), aggregate risk-weighted assets would increase by some
61
To translate this figure into an estimate of the aggregate increase in capital requirements, an assumption is
necessary on the aggregate (average) capital requirement ratio. For example, a capital requirement ratio of,
say, 8 % would lead to an increase in aggregate capital requirements of EUR 134 billion.
82
EUR 87 billion. For the steady state scenario in which SBBS reach a much larger scale
(i.e., EUR 1,500 billion), the equivalent calculation yields an increase in aggregate risk-
weighted assets to the tune of EUR 1.3 trillion. (SA) Banks could also decide to only
switch into senior tranches (provided some other investors purchase the sub-senior
tranches), in which case they would face no additional capital requirements.
Even these large amounts are much reduced relative to what would prevail before the
coming into force of Regulation (EU) 2017/2042 on 1/1/2019. The corresponding
calculation for a full switch (respectively, a switch of EUR100 billion) would yield
additional risk-weighted assets of EUR 2,985 trillion (respectively, EUR155 billion).
This larger amount reflects: (i) the fact that, in the status quo and before 1/1/2019, also
IRB banks would face capital charges on their holdings of tranches; and (ii) that also the
senior tranche would face a positive risk weight (assumed at 20% in this calculation).
3. PRESENTATION OF THE ANALYSIS BY THE ESRB LIQUIDITY WORKING GROUP ON
THE EFFECTS OF SBBS ON NATIONAL SOVEREIGN BOND MARKET LIQUIDITY
This section of annex 4 presents the assessment undertaken by the ESRB HLTF, shown
in section 4.4 in volume II of the report on the possible impact of SBBS on sovereign
bond market liquidity.
Concerns were raised regarding the impact of SBBS on sovereign bond market liquidity.
Given that one fraction of currently outstanding central government debt securities would
be "frozen" into SBBS portfolios they would be unavailable for trading.62
The analysis in
the ESRB report derives the implications of SBBS from the liquidity impact of the
Eurosystem's Public Sector Purchase Programme (PSPP).
On the other hand, SBBS would represent new securities with liquidity of their own. In
principle, SBBS could have properties that are comparable to current sovereign bonds,
including high liquidity and collateral eligibility. With a mature SBBS market, such
properties could have positive spillover effects with respect to national sovereign debt
markets. In this section these channels are referred to as the 'spillover effect' of SBBS.
At the same time, SBBS may also help to relieve scarcity of low-risk assets, which is
perceived by some market participants. German sovereign bonds in particular appear
scarce relative to demand, given the role of those bonds in acting as a benchmark asset
for the entire euro area. However, with a higher supply of low-risk assets (senior SBBS),
the excess demand for German sovereign bonds may be smaller. Using SBBS for repo
markets instead of sovereign bonds would contribute towards smooth market
functioning: for every 26 units of German bonds retained by SBBS issuers, there would
be 70 units of senior SBBS.
In the presence of both freezing effects and spillover effects, the net effect of SBBS on
the market liquidity of national sovereign markets is prima facie ambiguous. The
liquidity of SBBS and sovereign bond markets therefore depends on their relative size
62
This could be mitigated by allowing SBBS issuers to lend out the securities in reverse repos, as it is currently
done under the Eurosystem's implementation of its Public Sector Purchase Programme (PSPP). This would
however be at odds with the presumption that issuers would be mere pass-through vehicles.
83
and the corresponding strength of the offsetting freezing and spillover effects. If spillover
effects dominate, both SBBS and sovereign bond markets could be liquid. On the other
hand, if freezing effects dominate, there would be a trade-off between the liquidity of
SBBS and that of sovereign bonds. Also, there is a clear trade-off as the extent to which
SBBS may affect national sovereign debt markets depends on SBBS market size: a large
SBBS market implies adequate liquidity of the asset, but potentially at the expense of
national sovereign debt market liquidity. On the contrary, a small SBBS market would
have limited knock-on effects to national sovereign debt markets, but may consequently
itself be illiquid.
To shed more light on the expected net effect of SBBS on market liquidity, the rest of
this section examines the freezing and spillover effects in turn.
Liquidity impact
The PSPP63
programme is analogous to SBBS insofar as sovereign bonds are removed
from the secondary market but may be available for securities lending. It should however
be noted, that there are two key caveats to the conceptual analogy between PSPP and
SBBS: First, the analysis only holds if an SBBS market – and in particular a large SBBS
market – develops only after an unwinding of PSPP, as both measures together could
have an impact on liquidity of sovereign bond markets given their "freezing effect".
Second, the analogy between the two instruments is imperfect insofar as SBBS and PSPP
entail some important differences. In particular: (1) In parallel to the PSPP, the
Eurosystem implements a securities lending facility to support secondary market
liquidity by alleviating bond scarcity. (2) The PSPP is implemented in a market-neutral
manner, including with respect to maturities (eligible maturities range from 1-30 years).
However, in the early phase of the SBBS market, SBBS issuers might focus on certain
points of the curve – most likely 5- and 10-year debt securities – in order to build liquid
benchmarks to aid price discovery and facilitate the development of a futures market
referenced to SBBS. (3) While SBBS issuers could buy the SBBS cover pool on both the
secondary and the primary market, purchases under the PSPP take place exclusively in
secondary markets. (4) Purchases under the PSPP take place in a continuous manner to
avoid excessive market disruption, while purchases of the SBBS cover pool would most
likely take place in lumpy batches, corresponding to discrete SBBS issuance dates.
(5) An SBBS program would differ from the PSPP insofar as the former constitutes a
partial replacement of long-term bonds with different long-term bonds, while the PSPP is
essentially a partial replacement of long-term bonds with broad money. This implies that
SBBS could be a source of liquidity and hedging opportunities that would help dealers to
provide market liquidity elsewhere.
Nevertheless, the Eurosystem's PSPP represents a significant “stress test” of the likely
impact of SBBS on sovereign bond markets, since aggregate PSPP holdings (as of
63
The Eurosystem’s public sector purchase programme (PSPP) was implemented from 2015. It entails purchases
by the ECB and euro area national central banks of government debt securities and other eligible public
sector securities from the euro area. Purchased securities are effectively “frozen” on the collective balance
sheet of the Eurosystem, and are only available for use in securities financing transactions under the
conditions of the securities lending facility.
84
February 2017) amount to just under EUR 1.4 trillion, which is at the very upper range of
likely SBBS market size in its early years.
Sovereign bond market liquidity can be proxied by price-based and volume-based
indicators. The analysis reports time variation in three liquidity indicators, two of which
are price-based and one of which is volume-based. In principle, the time variation in
these indicators provides suggestive evidence regarding the limited impact of PSPP on
sovereign debt market liquidity.
As a first indicator bid-ask spreads at daily frequency from January 2014 to February
2017 from MTS are obtained.64
Figure 6 plots these bid-ask spreads over time by
country. Visually, there is no apparent general level shift in bid-ask spreads following the
commencement of PSPP purchases in March 2015, denoted by the vertical black line in
the figure. Figure 7 plots the bid-ask spread against the fraction of outstanding central
debt securities held by the Eurosystem under the PSPP to shed more light on the
relationship between bid-ask spreads and the PSPP. Overall, both figures do not show
any systematic evidence that PSPP holdings are associated with increases in bid-ask
spreads. The only Member States where bid-ask spreads appear to increase somewhat are
Germany and Austria. In particular for Germany65
this has to be considered with caution,
given the relatively low turnover of German Bunds on the MTS platform.
Figure 6: Normalised bid-ask spreads in bps over
time
Figure 7: Average best daily bid-ask spreads
against the fraction of outstanding
government debt securities held by the
Eurosystem under the PSPP
Source: Report of the ESRB HLTF; Data: MTS. Source: Report of the ESRB HLTF; Data: MTS.
The second indicator is also price based and consists of a proprietary liquidity index
computed by Tradeweb66
. Figure 8 shows Tradeweb's index plotted against time while in
64
MTS is an interdealer platform, focussed on euro-denominated securities and serves as a backstop for dealers
who are unable to manage their inventory through customer relationships. MTS bid-offer spreads therefore
tend to be relatively static and wider than actual market spreads in the more liquid market segments. In the
MTS dataset, bid-ask spreads are measured in basis points as the difference between the best bid and ask
price posted on the domestic and European MTS platforms, normalised by the mid-price, and averaged over
each trading day. Bids and asks are posted with respect to benchmark 10-year national sovereign bonds.
65
This is consistent with the findings of Schlepper et al. (2017) regarding overall Bund scarcity.
66
Tradeweb is a request-for-quote trading platform focused on the dealer-to-customer market segment.
Differently to MTS data (where data are based on quotes) Tradeweb data are based on transaction prices, i.e.
those generated by actual trades. Tradeweb’s index is intended to measure liquidity levels within specific
85
Figure 9 it is plotted against the fraction of outstanding central government debt
securities held by the Eurosystem under the PSPP. Despite the higher volatility in the
Tradeweb index67
, there is no systematic upward trend in Tradeweb’s liquidity index
across countries. Nevertheless, in the case of some countries, there appears to be a slight
worsening in the liquidity index at the beginning of 2017.68
Figure 8: Tradeweb liquidity index over time Figure 9: Tradeweb liquidity index against the
fraction of outstanding government debt
securities held by the Eurosystem under
the PSPP
Source: Report of the ESRB HLTF; Data: Tradeweb. Source: Report of the ESRB HLTF; Data: Tradeweb.
Figure 10: Tradeweb volume indicator Figure 11: Tradeweb volume indicator against the
fraction of outstanding government debt
securities held by the Eurosystem under
the PSPP
Source: Report of the ESRB HLTF; Data: Tradeweb. Source: Report of the ESRB HLTF; Data: Tradeweb.
The third indicator is volume-based and computed against both time (Figure 10) and
against the fraction of outstanding central government debt securities held by the
Eurosystem under the PSPP (Figure 11). The variable is calculated as the ratio of the
day’s notional traded volume over the average daily notional traded volume over the
preceding 90 days. This ratio is then mapped to one of five categories, so that the
Tradeweb volume indicator is a categorical variable, which can take the value of any
fixed income markets, based on transaction prices relative to the mid-price. The vertical lines refer to
9 March 2015, the beginning of the PSPP.
67
Tradeweb’s index is more volatile because it is based on trade sizes that are generally much smaller and
variable in size than those on MTS, as they reflect customer requests-for-quotes from a smaller number of
dealers. By contrast, the MTS platform is a transparent limit order market which is very competitive.
68
The data sample ends early 2017. To fully assess this apparent development, it would be important to obtain
more recent data over 2017, given that PSPP holdings have continued to increase.
86
integer between 1 and 5 inclusive, where 1 corresponds to low turnover and 5 to high
turnover.69
Across countries, the average value of the volume indicator is 2.8 over 2014-
16, suggesting a mild reduction in volumes traded. However, there is no change over
time: the indicator stands at 2.8 in 2014, 2015 and 2016, i.e. before and after the
introduction of the PSPP. The fourth indicator illustrates the effect of liquidity via the
Hasbrouck ratio. This is the ratio of the logarithmic daily price difference over total
turnover. Figure 12 plots the Hasbrouck ratio over time and Figure 13 against PSPP
holdings. Again, this indicator is in line with the findings illustrated in the previous
figures: there is not an observable worsening of liquidity over the program.
Figure 12: Hasbrouck ratio over time Figure 13: Hasbrouck ratio against the fraction of
outstanding government debt securities
held by the Eurosystem under the PSPP
Source: Report of the ESRB HLTF; Data: Tradeweb. Source: Report of the ESRB HLTF; Data: Tradeweb.
Lastly, a regression analysis is performed to provide a more rigorous assessment of the
impact of PSPP on sovereign bond market liquidity. In particular, panel regressions are
estimated, with normalised bid-ask spreads regressed on time and country fixed effects,
as well as the magnitude of PSPP holdings.
The relationship between cumulative
bond purchases and normalised bid-ask
spreads is not linear. The model that
best describes the data is cubic in
nature. This means that normalised bid-
ask spreads (=dependent variable) are
regressed on the first, second and third
powers of cumulative PSPP purchases
("pspp_cogovdebt", "pspp_cogovdebt2", "pspp_cgovdebt3"), as well as time and country
fixed effects.70
69
In particular, a value of 1 corresponds to ratio of less than or equal to 0.8, i.e. a “very low” turnover on that
day relative to the preceding 90 days; a value of 2 corresponds to a ratio between 0.8 and 0.9, i.e. a “below
average” turnover; a value of 3 corresponds to a ratio between 0.9 and 1.1, i.e. “average” turnover; a value of
4 corresponds to a ratio between 1.1 and 1.2, i.e. “above average” turnover; and a value of 5 corresponds to a
ratio of more than 1.2, i.e. “very high” turnover.
70
The first three powers of the cumulative PSPP purchase, country and time dummies are the independent
variables.
Table 12: Results of fixed effects panel regression
Coefficient Standard
error
P-value
pspp_cgovdebt 0.0052111 0.00192 0.007
pspp_cgovdebt2 -0.0003711 0.0001223 0.002
pspp_cgovdebt3 0.0000104 0.00000273 0
Constant 0.17423696 0.0024821 0
Source: Report of the ESRB HLTF.
87
The results of the panel regression (see Table 12) indicate that, controlling for unreported
time and country fixed effects, the normalised bid-ask spreads are only slightly affected
by PSPP purchases. As is evident from the table, the effect of the programme on
normalised bid-ask spreads is statistically significant, yet only minor in terms of
economic magnitude, as the figure below reveals.
Figure 14 plots the predicted level of normalised bid-ask spreads for different levels of
PSPP purchases using the results of the regression above. Specifically, the red line plots
the forecasted normalised bid-ask spread of euro area sovereign bonds for different levels
of cumulative PSPP purchases71
. The dots depict the actual normalised bid-ask spread
observations for each country, net of the country and time fixed effects calculated in the
panel regression.
It is clear from the figure that the
impact of the PSPP on bid ask
spreads is low. The mean share of
PSPP purchases in February 2017,
across the countries in the sample,
was around 17%. For that value,
we can observe that the mean euro
area normalised spreads show a
very small increase, by
approximately 3 basis points. As
program purchases move toward
the issuer limit of 33%, the
regression model predicts a small
deterioration in liquidity: PSPP
holdings at the 26% mark is
associated with around 6 basis points increase in spreads. However, only 3 countries
surpassed the 20% mark by end of February 2017, and the red line extends to account for
the highest observed share of central government bond purchases (Germany at 26%).
The analysis above has shown that the impact of the PSPP on sovereign bond market
liquidity was limited. Only in some Member States normalised bid-ask spreads show a
minor to mild increase.72
71
The fitted values in the red line are a forecast of euro area aggregate normalised bid-ask spreads and are
estimated using the coefficients in Table 12 on different values of cumulative PSPP purchases across
countries for each month in the time series.
72
Overall, these findings are consistent with those of Schneider, Lillo and Pelizzon (2016), who analyse
sovereign bond market liquidity over 2015 (in the months immediately following the commencement of the
PSPP). They find that five and 10-year Italian sovereign bonds remained liquid and stable over 2015,
consistent with the stable bid-ask spreads plotted for Italy in Figure 6. However, they also find that 30-year
Italian sovereign bonds turned illiquid over the same period, which is consistent with the view that PSPP
may have somewhat larger effects on liquidity levels in already less liquid segments of the market. Similarly,
using a high-frequency, transaction-level analysis of Bundesbank purchases of German bonds in the
framework of the PSPP, Schlepper, Hofer, Riordan and Schrimpf (2017) find that the price impact of
purchases was stronger when markets were less liquid. However, the exception to this generally benign
finding is Germany, where PSPP purchases appear to have induced a temporary deterioration in market
liquidity over short periods. In their analysis of PSPP purchases of German bunds, Schlepper et al (2017)
find that bid-ask spreads widened for purchased securities, particularly when compared to non-eligible
Figure 14: Actual vs fitted values of normalised bid-ask
spreads net of country and time fixed effects,
plotted against cumulative share of central
government bond purchases under the PSPP
Source: Report of the ESRB HLTF.
88
Spillover effects
The following analysis – also performed by the ESRB HLTF73
– shows that given the
relative neutrality (as compared to the PSPP) with respect to duration74
, positive spillover
effects may arise from SBBS owing to their provision of (i) collateral services and (ii)
hedging opportunities, conditional on SBBS attaining adequate liquidity and a regulatory
level playing field for SBBS.75
Overall, assuming regulation does not penalise netting
excessively, there is in prospect a significant improvement in trading costs across all
European sovereign debt markets if SBBS effectively become benchmark securities.
(i) Provision of collateral services: While repo markets in sovereign bonds are well
developed, this would not necessarily be the case for SBBS. Such an active repo market
could however develop over time, once the SBBS market increases in size and the
necessary infrastructure has developed.
(ii) Provision of hedging opportunities: If SBBS are adequately liquid, banks and other
investors could use an SBBS portfolio to hedge short or long positions in sovereign
bonds. SBBS could serve as relatively low-cost hedging instruments with euro area wide
characteristics, and would be particularly valuable to dealer banks that provide quotes in
sovereign bond markets.
For the subsequent assessment the following assumptions and data are used:
- It is assumed that SBBS markets would be deeper and more liquid than smaller euro
area sovereign bond markets.
- Estimated SBBS yields, based on an approach developed by Schönbucher (2003)76
,
are used to examine the effects of hedging. The yield estimation method relies on a
simulated default-triggering mechanism and a market-based indicator of default
probability applied to the underlying securities. Figure 15 shows the time series
behaviour of yields on SBBS under two alternative subordination assumptions (a)
70:30 and b) 70:20:10) and of a selection of sovereign bond yields (c). All data used
in the analysis has been converted to price and then daily holding period returns,
with an assumed duration of 9 years.
- Hedging effectiveness of SBBS is assessed by measuring the magnitude and
stability of time-varying correlations between single SBBS (portfolios) and
individual sovereign bonds.
- Correlations are measured using a range of methodologies, including dynamic
conditional correlating using CDD-GJR-GARCH(1,1) modelling.
bonds, while market depth was somewhat reduced for purchased securities (up to EUR 1.6 million per
EUR 100 million purchased), compared to non-purchased eligible bonds.
73
See chapter 4.4.2 of volume II of the ESRB HLTF report.
74
The PSPP provides liquidity to financial markets by swapping medium- and long-term debt securities for
central bank reserves. By contrast, an SBBS programme would swap national debt securities for SBBS
securities of identical duration.
75
An example, where securitisation improves market quality more widely than seems plausible at first glance is
the "to-be-announced" Agency Mortgage Backed Securities market in the US. An analysis concludes that the
presence of the "to-be-announced" market has had widespread beneficial effects on liquidity even where
mortgage pools are not cheapest to deliver on the "to-be-announced" contract (Gao et al. (2017).
76
See section 1.4 of the ESRB HLTF report for details on the estimation of SBBS yields.
89
- Subsequently, diversification benefits are measured by comparing the variance of a
portfolio of hedged positions (with weights based on debt outstanding) compared
with the variances in the component markets. The hedge selection and assessment
follows closely the comprehensive approach of Bessler et al (2016).77
The results of the hedging effectiveness are presented in Table 13 – Table 15. The
effectiveness for each hedge is assessed by comparing (taking the ratio of) the hedged
and unhedged standard deviation of returns and Values-at-Risk (i.e. the average of the
ratio of the 5% and 95% Value-at-Risk). The results show that in the pre-sovereign debt
crisis period hedge effectiveness is high for all Member States (Table 13). The best
hedges are highlighted in bold. In the case of the single hedge, it is the senior-SBBS that
gives the best protection. In almost all cases of a combined hedge (2 tranches) provides
some marginal improvement in hedge effectiveness compared to the single tranche
hedge. In many cases the best overall hedge is achieved with a combination of the three
SBBS tranches, but this might not be worthwhile from a cost perspective. Table 14
shows the summary statistics for hedged/unhedged relative risks during the sovereign
debt crisis. For the single (senior) tranche hedge, only Germany remains well hedged.
Roughly half of the risk is avoided by single SBBS hedging for the case of Finland and
the Netherlands. The two and three tranche hedges generally lead to some small but
significant risk reduction for most sovereigns compared to the single tranche hedge.
Table 15 shows the results for the post-crisis recovery period (07/2012-Q4/2016). Using
composite hedging usually reduces the risks by half or more, with the exceptions of
Greece and Portugal.
The daily return on the hedged and unhedged positions for the case of hedging with just
the senior and for the case of hedging with a mixture of the senior and the mezzanine
tranche are shown in Figure 16 – Figure 18. The figures show in general that hedging is
very effective in the pre-sovereign debt crisis period in reducing the variance of returns
(with some isolated exceptions). Hedging is not effective for high-risk sovereigns during
the height of the sovereign debt crisis but effectiveness returns to some extent during the
recovery. In general the combined hedge works better than the single hedge in the crises
and recovery periods. As regards particular countries, Figure 16 shows that hedging is
quite consistently effective for core countries (DE, FR and NL, and the same counts for
AT and FI which are not displayed). In these cases, the composite hedge seems to
eliminate the occasional blips present in the single hedge case. For non-core Member
States results are less clear: Figure 17 shows the cases of BE, ES and IT and clearly
reveals how idiosyncratic the effects are during the crisis. It is interesting that the
composite hedge (senior and mezzanine) works better than the single hedge during the
crisis and recovery (apart from one particular day). This tends to improve further with the
inclusion of the junior SBBS as a hedge instrument (this more general case is not
displayed in the figure but can be seen from the tabulated results yet to be discussed).
Figure 18 shows the more volatile cases of GR, IE and PT. There is also evidence of
hedge ineffectiveness during the crisis with improvement only obvious during the
recovery for IE and PT. Again, the composite hedge is better than the single hedge during
the recovery for these countries and is particularly good in protecting from the more
77
See section 4.4.2 of the ESRB HLTF report for further model details, used data and results.
90
extreme movements. Although hedging is often ineffective in these cases one has to
acknowledge that these are small markets and their idiosyncratic riskiness could easily be
diversified as part of a cross-country portfolio.
Figure 15: Estimated yields on SBBS and selected sovereigns (%)
a) 70:30 SBBS Yields
b) 70:20:10 SBBS Yields
c) Yields of DE, IT, GR & PT
Source: ESRB HLTF report. Note: Shaded area is euro area Sovereign Debt Crisis period (11/2009-08/2012).
91
Table 13: Hedge Effectiveness: Pre-Sovereign Debt Crisis
Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged
returns relative to the unhedged returns.
Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr
AT(i) 0.38 0.39 0.65 0.33 0.3 0.5 0.28
AT(ii) 0.27 0.28 0.65 0.23 0.18 0.43 0.16
BE(i) 0.35 0.37 0.64 0.28 0.25 0.48 0.23
BE(ii) 0.29 0.3 0.63 0.24 0.2 0.42 0.17
DE(i) 0.21 0.22 0.68 0.16 0.16 0.54 0.13
DE(ii) 0.15 0.19 0.69 0.14 0.12 0.51 0.11
ES(i) 0.45 0.45 0.64 0.38 0.34 0.47 0.31
ES(ii) 0.38 0.39 0.64 0.31 0.27 0.42 0.25
FI(i) 0.3 0.31 0.65 0.28 0.25 0.54 0.24
FI(ii) 0.21 0.23 0.64 0.19 0.16 0.47 0.16
FR(i) 0.28 0.29 0.63 0.22 0.2 0.47 0.17
FR(ii) 0.24 0.25 0.63 0.19 0.16 0.41 0.12
GR(i) 0.64 0.67 0.73 0.54 0.49 0.51 0.45
GR(ii) 0.54 0.56 0.67 0.4 0.4 0.42 0.33
IE(i) 0.58 0.6 0.74 0.53 0.49 0.61 0.48
IE(ii) 0.34 0.38 0.67 0.3 0.28 0.48 0.28
IT(i) 0.5 0.53 0.65 0.37 0.35 0.41 0.28
IT(ii) 0.44 0.5 0.63 0.31 0.3 0.36 0.23
NL(i) 0.31 0.32 0.63 0.25 0.22 0.46 0.19
NL(ii) 0.23 0.25 0.64 0.2 0.17 0.42 0.14
PT(i) 0.5 0.52 0.66 0.41 0.37 0.46 0.33
PT(ii) 0.38 0.4 0.62 0.31 0.27 0.39 0.23
92
Table 14: Hedge Effectiveness: Sovereign Debt Crisis
Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged
returns relative to the unhedged returns.
Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr
AT(i) 0.76 0.89 1 0.68 0.84 1.04 0.74
AT(ii) 0.68 0.81 0.98 0.59 0.61 0.95 0.59
BE(i) 0.97 0.96 0.98 0.73 1.1 0.84 0.8
BE(ii) 0.98 0.98 1 0.73 0.9 0.83 0.71
DE(i) 0.32 1 1.07 0.28 0.33 1.04 0.29
DE(ii) 0.31 1.04 1.05 0.27 0.31 0.95 0.27
ES(i) 1.01 1.1 1.01 0.67 1.1 0.69 0.72
ES(ii) 0.97 1.15 1.05 0.71 0.87 0.66 0.65
FI(i) 0.48 0.93 1.03 0.48 0.51 1.06 0.53
FI(ii) 0.46 0.96 1.02 0.46 0.46 1.04 0.45
FR(i) 0.77 0.88 1 0.65 0.85 1 0.69
FR(ii) 0.7 0.88 1.02 0.62 0.68 1.02 0.62
GR(i) 1 1.01 1 1 0.85 0.85 0.83
GR(ii) 0.96 1.13 1.11 1.02 1.26 1.28 1.23
IE(i) 1.02 1.07 1.02 0.97 1.01 0.98 1.01
IE(ii) 0.99 1.06 1.03 0.95 0.92 0.93 0.94
IT(i) 1 1.1 1.01 0.56 1.18 0.61 0.63
IT(ii) 1.02 1.13 1.03 0.6 0.91 0.57 0.56
NL(i) 0.51 0.91 1.02 0.52 0.54 1.07 0.57
NL(ii) 0.47 0.94 1.05 0.48 0.48 1.03 0.49
PT(i) 1.01 1.05 1.01 0.99 1.01 0.98 1
PT(ii) 1.01 1.02 1.01 0.95 0.9 0.92 0.91
93
Table 15: Hedge Effectiveness: Post-Sovereign Debt Crisis
Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged
returns relative to the unhedged returns.
Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr
AT(i) 0.55 0.78 1 0.53 0.51 0.9 0.51
AT(ii) 0.49 0.75 1 0.47 0.43 0.86 0.44
BE(i) 0.56 0.74 0.98 0.52 0.47 0.87 0.48
BE(ii) 0.5 0.72 0.97 0.47 0.43 0.85 0.43
DE(i) 0.27 0.87 1.04 0.26 0.27 0.92 0.25
DE(ii) 0.28 0.9 1.04 0.27 0.27 0.93 0.26
ES(i) 0.98 1.02 0.97 0.68 0.74 0.58 0.57
ES(ii) 0.96 0.94 0.96 0.71 0.72 0.59 0.57
FI(i) 0.48 0.84 1.01 0.47 0.45 0.91 0.45
FI(ii) 0.41 0.82 1.01 0.4 0.38 0.89 0.38
FR(i) 0.5 0.73 0.98 0.45 0.42 0.85 0.41
FR(ii) 0.46 0.72 0.98 0.44 0.39 0.84 0.39
GR(i) 1 1.07 1.07 0.92 0.92 1.02 0.92
GR(ii) 1.05 1.06 1.08 1.03 1.11 1.17 1.12
IE(i) 0.9 0.89 0.97 0.79 0.78 0.81 0.73
IE(ii) 0.86 0.83 0.95 0.71 0.72 0.77 0.65
IT(i) 0.97 1.01 0.96 0.59 0.72 0.5 0.47
IT(ii) 0.93 0.95 0.96 0.59 0.66 0.48 0.46
NL(i) 0.47 0.82 1.01 0.46 0.44 0.91 0.44
NL(ii) 0.4 0.82 1 0.39 0.36 0.89 0.35
PT(i) 1 1.02 1 0.87 0.85 0.79 0.79
PT(ii) 0.99 1.02 1 0.87 0.83 0.75 0.74
94
Figure 16: Single & Composite Hedging (DE, FR, NL) – returns measured in bps (left axis)
(a) DE: Single (senior) Hedge (b) DE: Composite (sen+mez) Hedge
(c) FR: Single (senior) Hedge (d) FR: Composite (sen+mez) Hedge
(e) NL: Single (senior) Hedge (f) NL: Composite (sen+mez) Hedge
Source: ESRB HLTF report.
95
Figure 17: Single & Composite Hedging (BE, ES, IT) – returns measured in bps (left axis)
(a) BE: Single (senior) Hedge (b) BE: Composite (sen+mez) Hedge
(c) ES: Single (senior) Hedge (d) ES: Composite (sen+mez) Hedge
(e) IT: Single (senior) Hedge (f) IT: Composite (sen+mez) Hedge
Source: ESRB HLTF report.
96
Figure 18: Single & Composite Hedging (GR, IE, PT) – returns measured in bps (left axis)
(a) GR: Single (senior) Hedge (b) GR: Composite (sen+mez) Hedge
(c) IE: Single (senior) Hedge (d) IE: Composite (sen+mez) Hedge
(e) PT: Single (senior) Hedge (f) PT: Composite (sen+mez) Hedge
Source: ESRB HLTF report.
97
4. IMPACT ON THE VOLUME OF AAA ASSETS
An estimation of the impact of the introduction of SBBS on the volume of AAA assets
available in the euro area has been carried out to compare the respective benefits of a
tranched product ('SBBS proper', i.e. Models 1 and 2) and the untranched basket (per
Model 5).
The calculation is based on Eurostat data on euro area central government debt as of
December 201678
, as well as Standard & Poor's ratings of euro area sovereign
governments on the same date79
.
The composition of the SBBS portfolio is based on the ECB capital key for each euro
area government. Two scenario are considered: a scenario where SBBS develop
gradually and reach a limited volume only (Limited volume scenario), and a steady state
scenario with significant volumes of SBBS.
The estimation is based on a static approach, whereby the impact of the SBBS
introduction is assessed against the volumes of central government debt as of 2016.
While this approach ignores the future evolution of (i) central government debt stocks
and (ii) euro area sovereign ratings over the forthcoming years, it nevertheless allows for
a robust comparison of the expected effects of options 1.2 and 1.3.
The analysis assumes that the senior tranche of the 'SBBS proper' will be granted an
AAA rating, while an untranched basket would not. The results are displayed in
Table 16.
Table 16: Impact of the SBBS on the volume of AAA assets in the euro area
(% of EA government debt rated AAA) Limited volume scenario Steady state scenario
SBBS proper (Models 1 and 2) +2% +30%
Basket (Model 5) -2% -25%
Source: European Commission
As shown in Table 16, the impact is negligible in the limited volume scenario (Year 5
after a gradual introduction), while in the steady state it could increase the amount of
euro area sovereign debt rated AAA by up to 30%, subject to the tranching of the SBBS
product. Indeed, a mere basket would conversely negatively impact the amount of EA
government debt rated AAA by 25% in the steady state scenario, since the basket is not
expected to be rated AAA.
78
Downloaded from Eurostat website on 21 December 2017 at 10:42.
79
Downloaded from S&P website on 21 December 2017.
98
5. IMPACT ON THE COMPOSITION OF BANKS' SOVEREIGN PORTFOLIOS
The impact of the introduction of the SBBS on banks' sovereign portfolios has been
assessed under both the limited volume scenario and the steady state scenario. This
calculation does not assess separately the SBBS proper from the basket, since the
diversification effect is assumed to be similar.
Using the data of the EBA transparency exercise as of 30 June 2017 and the latest ECB
capital key, the analysis calculates, for each bank in the sample (96 banks of the euro
area), the reduction in domestic holdings if banks decided to switch some of their
domestic holdings for new SBBS bonds. For sake of simplicity, it is assumed that each
bank would switch a proportion of its euro area sovereign portfolio similar to the overall
ratio of SBBS relative to the universe of euro area central government bonds, in each
scenario. It is also assumed that banks would only switch domestic government bonds
insofar as their weight in the bank's portfolio exceeds the capital key of that government
(home bias).
Table 17: Impact of the SBBS on the diversification of banks' sovereign portfolios
(Reduction of domestic holdings in %) Limited volume scenario Steady state scenario
SBBS proper (Models 1 and 2) -3% -34%
Source: European Commission
Table 17 shows that the impact would be small in the limited volume scenario, but
significant under the steady state scenario. Under those assumptions, the home bias in the
sample of euro area banks covered by the EBA transparency exercise would be reduced
by 42%.
Using the same sample of bank and the same assumptions, the impact of the introduction
of SBBS on the amount of AAA assets held in banks' sovereign portfolios is assessed.
The analysis is carried out for three models: model 1, model 2 and model 5. It is assumed
in model 2 that banks would only hold the senior tranche of the SBBS proper, while in
model 1 they would hold all the tranches. The junior and mezzanine tranches of the
SBBS proper (model 1 and 2) as well as the basket (model 5) are expected to be rated
below AAA.
Table 18: Impact of the SBBS on the amount of AAA assets in banks' sovereign portfolios
(share of sovereign holdings rated AAA in %) Actual Model 1 Model 2 Model 5
Limited volume scenario 24% 24% 24% 23%
Steady state scenario 24% 32% 33% 19%
Source: European Commission
As reported in Table 18, the impact would be negligible in the limited volume scenario,
and noticeable and positive in the steady state scenario for the SBBS proper option
(model 1 and 2), while it would be negative in the case of baskets (since the share of
AAA sovereign assets would drop from 24% to 19%).