EUROPEAN COMMISSION Brussels, 24.5.2018 SWD(2018) 252 final 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}



Table of contents 1.Introduction: Political and legal context 2.Problem definition 2.1.What is the problem? 2.2.What are the problem drivers? 2.3.How will the problem evolve? 3.Why should the EU act? 3.1.Legal basis 3.2.Subsidiarity (Necessity of EU action) 3.3.Subsidiarity (Value added of EU action) 4.Objectives: What is to be achieved? 4.1.General objectives 4.2.Specific objectives 5.What are the available policy options? 5.1.What is the baseline from which options are assessed? 5.2.Description of the policy options 5.3.Options discarded at an early stage 6.What are the impacts of the policy options? 6.1.Scenarios and benchmarks of benefits and costs

6.1.1. Scenarios 6.1.2. Benchmarks of benefits and costs 6.2.Scope of applicability of the proposed legislation 6.2.1. Option 1.1: only SBBS proper 6.2.2. Option 1.2: All securitisations of euro area sovereign bonds 6.2.3. Option 1.3: A basket of euro-are sovereign bonds (with weights according to the official "SBBS recipe") 6.2.4. Impact summary and conclusions 6.3.Extent of ’restored’ regulatory neutrality 6.3.1. Option 2.1: Extend the regulatory treatment of euro area sovereign bonds to all tranches 6.3.2. Option 2.2: Extend the regulatory treatment of euro area sovereign bonds only to senior tranches 6.3.3. Impact summary and conclusions 6.4.Ensuring compliance with SBBS criteria and consistency in implementation 6.4.1. Option 3.1: A compliance mechanism based on selfattestation 6.4.2. Option 3.2: Option 3.1, with the involvement of third-parties 6.4.3. Option 3.3: Option 3.1 with ex-ante supervisory checks on each issuance 6.4.4. Impact summary and conclusion 7.How do the options compare? 8.Preferred option 8.1.Preferred model 8.2.REFIT (simplification and improved efficiency)

9.How will actual impacts be monitored and evaluated? List of References Annex 1Procedural information 1.Lead DG, Decide Planning/CWP references 2.Organisation and timing 3.Consultation of the RSB 4.Evidence, sources and quality Annex 2Stakeholder consultation 1.Results from the ESRB Public Survey on Sovereign Bond-Backed Securities 1.1Senior SBBS 1.2Junior SBBS 1.3Regulation 1.4Economics of SBBS issuance 2.Summary of the Industry Workshop Session 1: Motivation Session 2: Sovereign debt markets Session 3: Commercial banks Session 4: Non-bank Investors Session 5: Demand for junior SBBS Session 6: Risk measurement

3.Main takeaways of the closed-door DMO workshop Annex 3Who is affected and how? 1.Practical implications of the initiative 2.Summary of costs and benefits Annex 4Analytical methods 1.Evidence on the extent of "hindrance" faced by SBBS at present 2.Evidence on the extent of "hindrance" faced by SBBS at post 1/1/2019 3.Presentation of the analysis by the ESRB liquidity working group on the effects of SBBS on national sovereign bond market liquidity 4.Impact on the volume of AAA assets 5.Impact on the composition of banks' sovereign portfolios 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 1.Introduction: Political and legal context A novel concept—that of Sovereign Bond-Backed Securities, or SBBS (see Box 1 )—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 Eurobonds 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 Paper 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 euroarea 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. An interinstitutional 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).

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 term 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 highquality 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 concluded 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. A key necessary condition, however, is for an SBBSspecific 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. 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. 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. 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 highquality 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 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). 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. 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. 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 balance sheets, and subsequent public intervention put significant strain on the finances of their respective sovereigns. 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) euroarea 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. 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. 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. Finally, domestic banks may be subject to "moral suasion". In particular, government-owned 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 Error! No bookmark name given.). 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. 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. 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. In particular, as per the Capital Requirements Regulation (CRR, Regulation (EU) No 575/2013, Articles 242-270), generally 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. isk 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. 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 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. 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. 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 operations (the latter is considered a necessary, but not 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. 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. ·The Money Market Funds Regulation currently under negotiation 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. ·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. 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 visàvis 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 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, 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 visàvis 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 "lookthrough" 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 Pillar1 capital requirement purposes would be established also for subsenior tranches for the subset of banks using Internal-Ratings Based models (IRBAbanks), but not for others. 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). 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 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. 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. 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 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 crosssection 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 lowrisk/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. 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. 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 (henceforth, "SA banks") would still face large capital requirements when holding subsenior 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 treatment—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 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 "crossinstrument" 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. 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. 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%). 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. 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) marketmaking 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. 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. 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 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". 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. 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. 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. 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.

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 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. 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 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). 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). 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 AAArated 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. 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.

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 tranche 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 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. 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 scenarioany 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 HQLAeligible securities available to market participants, 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 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. 6.4.Ensuring compliance with SBBS criteria and consistency in implementation 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 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. 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 selfattestation 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 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 selfattestation 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 co