GREEN PAPER on the feasibility of introducing Stability Bonds
Date: 2011-11-23
Institutions: European Commission
Subjects: economic integration, economic recession, economic situation, euro area, financial market, governance, treasury bill

EUROPEAN COMMISSION 

Brussels, 23.11.2011 
COM(2011) 818 final 

GREEN PAPER 

on the feasibility of introducing Stability Bonds 

 
 
 
 
  
 
GREEN PAPER 

on the feasibility of introducing Stability Bonds 

1. 

RATIONALE AND PRE-CONDITIONS FOR STABILITY BONDS

1 

1.1. 

Background  

This Green Paper has the objective to launch a broad public consultation on the concept 
of Stability Bonds, with all relevant stakeholders and interested parties, i.e. Member States, 
financial market operators, financial market industry associations, academics, within the EU 
and beyond, and the wider public as a basis for allowing the European Commission to identify 
the appropriate way forward on this concept. 

The document assesses the feasibility of common issuance of sovereign bonds (hereafter 
issuance")  among  the  Member  States  of  the  euro  area  and  the 
"common 
requiredconditions2. Sovereign issuance in the euro area is currently conducted by Member 
States  on  a  decentralised  basis,  using  various  issuance  procedures.  The  introduction  of 
commonly  issued  Stability  Bonds  would  mean  a  pooling  of  sovereign  issuance  among  the 
Member  States  and  the  sharing  of  associated  revenue  flows  and  debt-servicing  costs.  This 
would  significantly  alter  the  structure  of  the  euro-area  sovereign  bond  market,  which  is  the 
largest segment in the euro-area financial market as a whole (see Annex 1 for details of euro-
area sovereign bond markets).  

The concept of common issuance was first discussed by Member States in the late 1990s, 
when  the  Giovannini  Group  (which  has  advised  the  Commission  on  capital-market 
developments related to the euro) published a report presenting a range of possible options for 
co-ordinating  the  issuance  of  euro-area  sovereign  debt3.  In  September  2008,  interest  in 
common  issuance  was  revived  among  market  participants,  when  the  European  Primary 
Dealers  Association  (EPDA)  published  a  discussion  paper  "A  Common  European 
Government Bond"4. This paper confirmed that euro-area government bond markets remained 
highly fragmented  almost  10  years  after the introduction of the  euro  and  discussed  the pros 
and cons of common issuance. In 2009, the Commission services again discussed the issue of 
common issuance in the EMU@10 report. 

The intensification of the euro-area sovereign debt crisis has triggered a wider debate on 
the  feasibility  of  common  issuance5.  A  significant  number  of  political  figures,  market 

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The  public  discussion  and  literature  normally  uses  the  term  "Eurobonds".  The  Commission  considers 
that  the  main  feature  of  such  an  instrument  would  be  enhanced  financial  stability  in  the  euro  area. 
Therefore, in line with President Barroso's State of the Union address on 28 September 2011, this Green 
Paper refers to "Stability Bonds".  
In  principle,  common  issuance  could  also  extend  to  non-euro  area  Member  States  but  would  imply 
exchange rate risk. Several non-euro area Member States have already a large part of their obligations 
denominated in euro, so this should not represent a significant obstacle. All EU Member States might 
have an interest in joining the Stability Bond, especially if that would help reducing and securing their 
funding costs and generates positive effects on the economy through the internal market. From the point 
of view of the Stability Bond, the higher the number of Member States participates, the bigger are likely 
to be the positive effects, notably stemming from larger liquidity.  
Giovannini  Group:  Report  on  co-ordinated  issuance  of  public  debt  in  the  euro  area  (11/2000). 
http://ec.europa.eu/economy_finance/publications/giovannini/giovannini081100en.pdf. 
See  A  European  Primary  Dealers  Association  Report  Points  to  the  Viability  of  a  Common  European 
Government Bond, http://www.sifma.org/news/news.aspx?id=7436.  
See Annex 2 for an overview of analytical contributions to the Stability Bonds debate. 

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analysts and academics have promoted the idea of common issuance as a potentially powerful 
instrument  to  address  liquidity  constraints  in  several  euro-area  Member  States.  Against  this 
background, the European Parliament requested the Commission to investigate the feasibility 
of common issuance in the context of adopting the legislative package on euro-area economic 
governance,  underlining  that  the  common  issuance  of  Stability  Bonds  would  also  require  a 
further move towards a common economic and fiscal policy6. 

While  common  issuance  has  typically  been  regarded  as  a  longer-term  possibility,  the 
more  recent  debate  has  focused  on  potential  near-term  benefits  as  a  way  to  alleviate 
tension  in  the  sovereign  debt  market.  In  this  context,  the  introduction  of  Stability  Bonds 
would not come at the end of a process of economic and fiscal convergence, but would come 
in  parallel  with  further  convergence  and  foster  the  establishment  and  implementation  of  the 
necessary  framework  for  such  convergence.  Such  a  parallel  approach  would  require  an 
immediate and decisive advance in the process of economic, financial and political integration 
within the euro area. 

The Stability Bond would differ from existing jointly issued instruments. Stability Bonds 
would  be  an  instrument  designed  for  the  day-to-day  financing  of  euro-area  general 
governments  through  common  issuance.  In  this  respect,  they  should  be  distinguished  from 
other jointly issued bonds in the European Union and euro area, such as issuance to finance 
external assistance to Member States and third countries7. Accordingly, the scale of Stability 
Bond issuance would be much larger and more continuous than that involved in the existing 
forms of national or joint issuance.  

Issuance  of  Stability  Bonds  could  be  centralised  in  a  single  agency  or  remain 
decentralised  at  the  national  level  with  tight  co-ordination  among  the  Member  States. 
The  distribution  of  revenue  flows  and  debt-servicing  costs  linked  to  Stability  Bonds  would 
reflect  the  respective  issuance  shares  of  the  Member  States.  Depending  on  the  chosen 
approach  to  issuing  Stability  Bonds,  Member  States  could  accept  joint-and-several  liability 
for  all  or  part  of  the  associated  debt-servicing  costs,  implying  a  corresponding  pooling  of 
credit risk.  

Many  of  the  implications  of  Stability  Bonds  go  well  beyond  the  technical  domain  and 
involve issues relating to national sovereignty and the process of economic and political 
integration.  These  issues  include  reinforced  economic  policy  coordination  and  governance, 

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European  Parliament  Resolution  of  6  July  2011  on  the  financial,  economic  and  social  crisis: 
recommendations  concerning  the  measures  and  initiatives  to  be  taken  (2010/2242(INI))  states:  
" …13. Calls on the Commission to carry out an investigation into a future system of Eurobonds, with a 
view to determining the conditions under which such a system would be beneficial to all participating 
Member  States  and  to  the  euro  area  as  a  whole;  points  out  that  Eurobonds  would  offer  a  viable 
alternative  to  the  US  dollar  bond  market,  and  that  they  could  foster  integration  of  the  European 
sovereign debt market, lower borrowing costs, increase liquidity, budgetary discipline and compliance 
with the Stability and Growth Pact (SGP), promote coordinated structural reforms, and make capital 
markets  more  stable,  which  will  foster  the  idea  of  the  euro  as  a  global  ‘safe  haven’;  recalls  that  the 
common issuance of Eurobonds requires a further move towards a common economic and fiscal policy; 
14. Stresses, therefore, that when Eurobonds are to be issued, their issuance should be limited to a debt 
ratio of 60% of GDP under joint and several liability as senior sovereign debt, and should be linked to 
incentives  to  reduce  sovereign  debt  to  that  level;  suggests  that  the  overarching  aim  of  Eurobonds 
should  be  to  reduce  sovereign  debt  and  to  avoid  moral  hazard  and  prevent  speculation  against  the 
euro;  notes  that  access  to  such  Eurobonds  would  require  agreement  on,  and  implementation  of, 
measurable programmes of debt reduction;". 
E.g. bonds issued by the Commission under the Balance of Payments Facility/EFSM and bonds issued 
by  the  EFSF  or  issuance  to  finance  large-scale  infrastructure  projects  with  a  cross-country  dimension 
(e.g. project bonds to be possibly issued by the Commission). The various types of joint issuance and 
other instruments similar to Stability Bonds are discussed in Annex 3. 

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and a higher degree of economic convergence, and, under some options, the need for Treaty 
changes.  The  more  extensively  credit  risk  would  be  pooled  among  sovereigns,  the  lower 
would be market volatility but also market discipline on any individual sovereign. Thus fiscal 
stability  would  have  to  rely  more  strongly  on  discipline  provided  by  political  processes. 
Equally, some of the pre-conditions for the success of Stability Bonds, such as a high degree 
of  political  stability  and  predictability  or  the  scope  of  backing  by  monetary  authorities,  go 
well beyond the more technical domain. 

Any type of Stability Bond would have to be accompanied by a substantially reinforced 
fiscal  surveillance  and  policy  coordination  as  an  essential  counterpart,  so  as  to  avoid 
moral  hazard  and  ensure  sustainable  public  finances  and  to  support  competitiveness 
and reduction of harmful macroeconomic imbalances.  

This would necessarily have implications for fiscal sovereignty, which calls for a substantive 
debate in euro area member states.  

As such issues require in-depth consideration, this paper has been adopted by the Commission 
so  as  to  launch  a  necessary  process  of  political  debate  and  public  consultation  on  the 
feasibility of and the pre-conditions for introducing Stability Bonds.  

1.2. 

Rationale 

The debate on common issuance has evolved considerably since the launch of the euro. 
Initially,  the  rationale  for  common  issuance  focused  mainly  on  the  benefits  of  enhanced 
market  efficiency  through  enhanced  liquidity  in  euro-area  sovereign  bond  market  and  the 
wider  euro-area  financial  system.  More  recently,  in  the  context  of  the  ongoing  sovereign 
crisis,  the  focus  of  debate  has  shifted  toward  stability  aspects.  Against  this  background,  the 
main benefits of common issuance can be identified as:  

1.2.1.  Managing the current crisis and preventing future sovereign debt crises  

The  prospect  of  Stability  Bonds  could  potentially  alleviate  the  current  sovereign  debt 
crisis, as the high-yield Member States could benefit from the stronger creditworthiness 
of the low-yield Member States. Even if the introduction of Stability Bonds could take some 
time (see Section 2), prior agreement on common issuance could have an impact on market 
expectations and thereby lower average and marginal funding costs for those Member States 
currently  facing  funding  pressures.  However,  for  any  such  effect  to  be  durable,  a  roadmap 
towards common bonds would have to be accompanied by parallel commitments to stronger 
economic  governance,  which  would  guarantee  that  the  necessary  budgetary  and  structural 
adjustment to assure sustainability of public finances would be undertaken. 

1.2.2.  Reinforcing financial stability in the euro area 

Stability  Bonds  would  make  the  euro-area  financial  system  more  resilient  to  future 
adverse  shocks  and  so  reinforce  financial  stability.  Stability  Bonds  would  provide  all 
participating Member States with more secure access to refinancing, preventing a sudden loss 
of  market  access  due  to  unwarranted  risk  aversion  and/or  herd  behaviour  among  investors. 
Accordingly, Stability Bonds would help to smooth market volatility and reduce or eliminate 
the need for costly support and rescue measures for Member States temporarily excluded from 
market financing. The positive effects of such bonds are dependent on managing the potential 
disincentives  for  fiscal  discipline.  This  aspect  will  be  discussed  more  thoroughly  in 
Section 1.3 and Section 3. 

The  euro-area  banking  system  would  benefit  from  the  availability  of  Stability  Bonds. 
Banks typically hold large amounts of sovereign bonds, as low-risk, low-volatility and liquid 
investments.  Sovereign  bonds  also  serve  as  liquidity  buffers,  because  they  can  be  sold  at 

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relatively  stable  prices  or  can  be  used  as  collateral  in  refinancing  operations.  However,  a 
significant  home  bias  is  evident  in  banks'  holdings  of  sovereign  debt,  creating  an  important 
link between their balance sheets and the balance sheet of the domestic sovereign. If the fiscal 
position of the domestic sovereign deteriorates substantially, the quality of available collateral 
to  the  domestic  banking  system  is  inevitably  compromised,  thereby  exposing  banks  to 
refinancing risk both in the interbank market and in accessing Eurosystem facilities. Stability 
Bonds  would  provide  a  source  of  more  robust  collateral  for  all  banks  in  the  euro  area, 
reducing  their  vulnerability  to  deteriorating  credit  ratings  of  individual  Member  States. 
Similarly,  other  institutional  investors  (e.g.  life  insurance  companies  and  pension  funds), 
which tend to hold a relatively high share of domestic sovereign bonds, would benefit from a 
more homogenous and robust asset in the form of a Stability Bond.  

1.2.3.  Facilitating transmission of monetary policy  

Stability  Bonds  would  facilitate  the  transmission  of  euro-area  monetary  policy.  The 
sovereign  debt  crisis  has  impaired  the  transmission  channel  of  monetary  policy,  as 
government  bond  yields  have  diverged  sharply  in  highly  volatile  markets.  In  some  extreme 
cases,  the  functioning  of  markets  has  been  impaired  and  the  ECB  has  intervened  via  the 
Securities Market Programme. Stability Bonds would create a larger pool of safe and liquid 
assets. This would help in ensuring that the monetary conditions set by the ECB would pass 
smoothly  and  consistently  through  the  sovereign  bond  market  to  the  borrowing  costs  of 
enterprises and households and ultimately into aggregate demand.  

1.2.4. 

Improving market efficiency 

Stability Bonds would promote efficiency in the euro-area sovereign bond market and in 
the broader euro-area financial system. Stability Bond issuance would offer the possibility 
of a large and highly liquid market, with a single benchmark yield in contrast to the current 
situation  of  many  country-specific  benchmarks.  The  liquidity  and  high  credit  quality  of  the 
Stability  Bond  market  would  deliver  low  benchmark  yields,  reflecting  correspondingly  low 
credit  risk  and  liquidity  premiums  (see  Box 1).  A single  set  of  “risk  free”  Stability  Bond 
benchmark yields across the maturity spectrum would help to develop the bond market more 
broadly, stimulating issuance by non-sovereign issuers, e.g. corporations, municipalities, and 
financial  firms.  The  availability  of  a  liquid  euro-area  benchmark  would  also  facilitate  the 
functioning  of  many  euro-denominated  derivatives  markets.  The  introduction  of  Stability 
Bonds  could  be  a  further  catalyst  in  integrating  European  securities  settlement,  in  parallel 
with the planned introduction of the ECB's Target2 Securities (T2S) pan-European common 
settlement platform and possible further regulatory action at EU level. In these various ways, 
the  introduction  of  Stability  Bonds  could  lead  to  lower  financing  costs  for  both  the  public 
sector  and  the  private  sector  in  the  euro  area  and  thereby  underpin  the  longer-term  growth 
potential of the economy. 

Box 1: The expected yield of Stability Bonds – the empirical support  
The introduction of Stability Bonds should enhance liquidity in euro-area government bond markets, 
thereby  reducing  the  liquidity  premium  investors  implicitly  charge  for  holding  government  bonds. 
This box presents an attempt to quantify how large the cost savings through a lower liquidity premium 
could be. A second component of the expected yield on Stability Bonds, namely the likely credit risk 
premium has proven more controversial. Both the liquidity and credit premiums for a Stability Bond 
would crucially depend on the options chosen for the design and guarantee structure of such bonds. 

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Several  empirical  analyses  compared  the  yield  of  hypothetical  commonly-issued  bonds  with  the 
average yield of existing bonds. These analyses assume that there is neither a decline in the liquidity 
premium nor any enhancement in the credit risk by the common issuance beyond the average of the 
ratings of Member States. Carstensen (2011) estimated that the yield on common Bonds, if simply a 
weighted average of interest rates of Member States, would be 2 percentage points above the German 
10-year  Bund.  Another  estimate  (Assmann,  Boysen-Hogrefe  (2011),  )  concluded  that  the  yield 
difference to German bunds could be 0.5 to 0.6 of a percentage point. The underlying reasoning is that 
fiscal  variables  are  key  determinants  of  sovereign  bond  spreads.  In  fiscal  terms,  the  euro-area 
aggregate  would  be  comparable  to  France;  therefore  the  yield  on  common  bonds  would  be  broadly 
equal to that on French bonds. An analysis by J.P Morgan (2011), using a comparable approach, yields 
a similar range of around 0.5 to 0.6 of a percentage point. A further analysis along these lines by the 
French  bank  NATIXIS  (2011)  suggests  that  common  bonds  could  be  priced  about  20  basis  points 
above currently AAA-rated bonds. Favero and Missale (2010) claim that US yields, adjusted for the 
exchange  rate  premium,  are  a  good  benchmark  for  yields  on  common  bonds,  because  such  bonds 
would aim to make the euro-area bond markets similar to the US market in terms of credit risk and 
liquidity. They find that in the years before the financial crisis the yield disadvantage of German over 
US  government  bonds  was  around  40  basis  points,  which  would  then  represent  the  liquidity  gains 
obtained from issuing common bonds under the same conditions as US bonds. 

In order to provide an estimate of the attainable gains in the liquidity premium, the Commission has 
conducted a statistical analysis of each issuance of sovereign bonds in the euro area after 1999. The 
size of the issuance is used as an approximation (as it is the most broadly available indicator even if it 
might underestimate the potential gain in liquidity premia) of how liquid a bond issuance is, and the 
coefficient  in  a  regression  determines  the  attainable  gains  from  issuing  bonds  in  higher  volumes8. 
A first model is estimated using data on AAA-rated euro-area Member States (labelled "AAA" in the 
table), and a second model is estimated using data on all available euro-area Member States (labelled 
"AA"). The second model also controls for the rating of each issuance. It emerges that all coefficients 
are  significant  at  conventional  levels,  and  between  70  and  80%  of  the  variation  is  explained  by  the 
estimation. 

Table: Model estimates and expected change in yield due to lower liquidity premium

Yield (%) – model based
Yield change with US market size

Historical average 1999-2011
AAA
3.63
-0.09

DE
3.68
-0.07

AA
3.87
-0.17

2011 market conditions
DE
AA
AAA
2.63
2.43
1.92
-0.17
-0.17
-0.07

To  obtain  the  gain  in  the  liquidity  premium,  the  coefficients  from  the  model  estimate  were  used  to 
simulate the potential fall in yields of bonds that were issued in the average US issuance size rather 
than the average euro-area issuance volume. Hence, the US’s issuance size serves as a proxy for how 
liquid a Stability Bond market might become. In a first set of calculation, the liquidity advantage was 
derived  from  the  average  historical  “portfolio”  yield  since  1999.  For  comparison,  the  same 
calculations were made assuming the market conditions of summer 2011. 

8 

The  issuance  sizes  as  recorded  in  Dealogic  have  been  adjusted  to  incorporate  the  size  of  adjacent 
issuances with similar maturity and settlement date. To adjust for differences in time-dependent market 
conditions,  control  variables  are  introduced  for  the  impact  of  the  level  of  the  interest  rate  (the  2-year 
swap  rate)  and  of  the  term  structure  (the  difference  between  the  10-year  and  the  2-year  swap  rates) 
prevailing at the time of each issuance. 

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The table's second row indicates that the yield gain due to higher issuing volume would be in the range 
of  10  to  20  basis  points  for  the  euro  area,  depending  on  the  credit  rating  achieved,  but  rather 
independent on whether the historical or recent market conditions were used. The corresponding gain 
in  the  yield  for  Germany  would  be  around  7  basis  points.  The  simulations  demonstrate  that  the 
expected gain in the liquidity premium is rather limited and decreases for Member States that already 
benefit from the highest rating.  

While it is obvious that the Members States currently facing high yields would benefit from both the 
pooling  of  the  credit  risk  and  the  improved  liquidity  of  the  common  bonds,  the  current  low-yield 
Member  States  could  face  higher yields  in  the  absence  of  any  improvement  in  the  credit  risk  of  the 
current  high-yield  issuers.  In  principle,  compensatory  side  payments  could  redistribute  the  gains 
associated  with  the  liquidity  premium,  but  in  the  absence  of  better  governance  the  overall  credit 
quality  of  the  euro  area  debt  could  in  fact  deteriorate  as  a  result  of  weaker  market  discipline  to  the 
extent that the current low-yield Member States would face increased funding costs. 

1.2.5.  Enhancing the role of the euro in the global financial system 

Stability  Bonds  would  facilitate  portfolio  investment  in  the  euro  and  foster  a  more 
balanced global financial system. The US Treasury market and the total euro-area sovereign 
bond market are comparable in size, but fragmentation in euro-denominated issuance means 
that  much  larger  volumes  of  Treasury  bonds  are  available  than  for  any  of  the  individual 
national  issuers  in  the  euro  area.  On  average  since  1999,  the  issuance  size  of  10-year  US 
Treasury bonds has been almost twice the issuing size of the Bund and even larger than bonds 
issued by any other EU Member State. According to available data, trading volumes in the US 
Treasury  cash  market  are  also  a  multiple  of  those  on  the  corresponding  euro-area  market, 
where liquidity has migrated to the derivatives segment. High liquidity is one of the factors 
contributing  to  the  prominent  and  privileged  role  of  US  Treasuries  in  the  global  financial 
system (backed by the US dollar as the sole international reserve currency), thereby attracting 
institutional  investors.  Accordingly,  the  larger  issuance  volumes  and  more  liquid  secondary 
markets implied  by Stability Bond issuance would strengthen the position of the euro as an 
international reserve currency.  

1.3. 

Preconditions  

While Stability Bonds would provide substantial benefits in terms of financial stability 
and economic efficiency, it would be essential to address potential downsides. To this end, 
important  economic,  legal  and  technical  preconditions  would  need  to  be  met.  These  pre-
conditions, which could imply Treaty changes and substantial adjustments in the institutional 
design of EMU and the European Union, are discussed below.  

1.3.1.  Limiting moral hazard  

Stability  Bonds  must  not  lead  to  a  reduction  in  budgetary  discipline  among  euro-area 
Member  States.  A  notable  feature  of  the  period  since  the  launch  of  the  euro  has  been 
inconsistency  in  market  discipline  of  budgetary  policy  in  the  participating  Member  States. 
The high degree of convergence in euro-area bond yields during the first decade of the euro 
was  not,  in  retrospect,  justified  by  the  budgetary  performance  of  the  Member  States.  The 
correction  since  2009  has  been  abrupt,  with  possibly  some  degree  of  overshooting.  Despite 
this  inconsistency,  the  more  recent  experience  confirms  that  markets  can  discipline  national 
budgetary  policies  in  the  euro  area.  With  some  forms  of  Stability  Bonds,  such  discipline 
would  be  reduced  or  lost  altogether  as  euro-area  Member  States  would  pool  credit  risk  for 
some  or  all  of  their  public  debt,  implying  a  risk  of  moral  hazard.  Moral  hazard  inherent  in 
common  issuance  arises  since  the  credit  risk  stemming  from  individual  lack  of  fiscal 
discipline would be shared by all participants. 

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As the issuance of Stability Bonds may weaken market discipline, substantial changes in 
the framework for economic governance in the euro area would be required. Additional 
safeguards to assure sustainable public finances would be warranted. These safeguards would 
need  to  focus  not  only  on  budgetary  discipline  but  also  on  economic  competitiveness  (see 
Section 3). While the adoption of the new economic governance package already provides a 
significant safeguard to be further reinforced by new regulations based on Article 1369, there 
may be a need to go still further in the context of  Stability  Bonds – notably if a pooling of 
credit risk was to be involved. If Stability Bonds were to be seen as a means to circumvent 
market  discipline,  their  acceptability  among  Member  States  and  investors  would  be  put  in 
doubt.  

While  prudent  fiscal  policy  in  good  times  and  a  swift  correction  of  any  deviation  from  that 
path  are  the  core  of  responsible,  stability-orinetd  policy  making,  experience  has  shown  that 
broader  macroeconomic  imbalances,  including  competitiveness  losses,  can  have  a  very 
detrimental effect on public finances. Therefore, the stronger policy coordination required by 
the  introduction  of  the  Stability  Bonds  must  apply  also  to  avoiding  and  correcting  harmful 
macroeconomic imbalances.  
Ensuring high credit quality and that all Member States benefit from Stability Bonds 

Stability  Bonds  would  need  to  have  high  credit  quality  to  be  accepted  by  investors. 
Stability Bonds should be designed and issued such that investors consider them a very safe 
investment.  Consequently,  the  acceptance  and  success  of  Stability  Bonds  would  greatly 
benefit from the highest rating possible. An inferior rating could have a negative impact on its 
pricing (higher yield than otherwise) and on investors' willingness to absorb sufficiently large 
amounts  of  issuance.  This  would  particularly  be  the  case  if  Member  States'  national  AAA 
issuance would continue and thereby co-exist and compete with Stability Bonds. High credit 
quality would also be needed to establish Stability Bonds as an international benchmark and 
to  underpin  the  development  and  efficient  functioning  of  related  futures  and  options 
markets.10  In  this  context,  the  construction  of  Stability  Bonds  would  need  to  be  sufficiently 
transparent  to  allow  investors  to  price  the  underlying  guarantees.  Otherwise,  there  is  a  risk 
that  investors  would  be  sceptical  of  the  new  instrument  and  yields  would  be  considerably 
higher than the present yields for the more credit-worthy Member States.  

Achieving  a  high  credit  quality  will  also  be  important  to  ensure  the  acceptance  of 
Stability Bonds by all euro-area Member States. One key issue is how risks and gains are 
distributed across Member States. In some forms, Stability Bonds would mean that Member 
States  with  a  currently  below-average  credit  standing  could  obtain  lower  financing  costs, 
while Member States that already enjoy a high credit rating may even incur net losses, if the 
effect of the pooling of risk dominated the positive liquidity effects. Accordingly, support for 
Stability Bonds among those Member States already enjoying AAA ratings would require an 
assurance of a correspondingly high credit quality for the new instrument so that the financing 
costs  of  their  debt  would  not  increase.  As  explained,  this  again  would  rest  on  a  successful 

9 

10 

Proposal  for  a  Regulation  of  the  European  Parliament  and  of  the  Council  on  common  provisions  for 
monitoring and assessing draft budgetary plans and ensuring the correction of excessive deficit of the 
Member  States  in  the  euro  area;  Proposal  for  a  Regulation  of  the  European  Parliament  and  of  the 
Council  on  common  provisions  for  monitoring  and  assessing  draft  budgetary  plans  and  ensuring  the 
correction of excessive deficit of the Member States in the euro area.  
The experience of rating the EFSF bonds has showed that a rating of the bond superior to the average 
guarantees made by participating Member States was accomplished by different tools such as holding 
cash buffers, loss-absorbing capital and over-guaranteeing the issuance size. While these elements have 
been complex to manage in the case of the EFSF, they may prove useful in reinforcing the credit rating 
of the Stability Bond. 

EN 

8 

   EN 

 
                                                 
reduction of moral hazard. The acceptability of Stability Bonds might be further assured by a 
mechanism  to  redistribute  some  of  the  funding  advantages  between  the  higher-and  lower-
rated Member States (see Box 2).  

The credit rating for Stability Bonds would primarily depend on the credit quality of the 
participating Member States and the underlying guarantee structure11. 

–  With several (not joint) guarantees, each guaranteeing Member State would be liable for 
its share of liabilities under the Stability Bond according to a specific contribution key12. 
Provided that Member States would continue to obtain specific ratings, a downgrade of a 
large  Member  State  would  be  very  likely  to  result  in  a  corresponding  downgrade  of  the 
Stability  Bond,  although  this  would  not  necessarily  have  an  impact  on  the  rating  of  the 
other  Member  States.  In  present  circumstances  with  only  six  AAA  euro-area  Member 
States, a Stability Bond with this guarantee structure would most likely not be assigned an 
AAA  credit  rating  and  could  even  be  rated  equivalently  with  the  lowest-rated  Member 
State, unless supported by credit enhancement. 

–  With  several  (not  joint)  guarantees  enhanced  by  seniority  and  collateral,  each 
guaranteeing Member State would again remain liable for its own share of Stability Bond 
issuance. However, to ensure that Stability Bonds would always be repaid, even in case of 
default, a number of credit enhancements could be considered by the Member States. First, 
senior status could be applied to Stability Bond issuance. Second, Stability Bonds could be 
partially  collateralised  (e.g.  using  cash,  gold,  shares  of  public  companies  etc.).  Third, 
specific  revenue  streams  could  be  earmarked  to  cover  debt  servicing  costs  related  to 
Stability  Bonds.  The  result  would  be  that  the  Stability  Bonds  would  achieve  an  AAA 
rating,  although  the  ratings  on  the  national  bonds  of  less  credit-worthy  Member  States 
would be likely to experience a relative deterioration.  

–  With  joint  and  several  guarantees,  each  guaranteeing  Member  State  would  be  liable  not 
only  for  its  own  share  of  Stability  Bond  issuance  but  also  for  the  share  of  any  other 
Member  State  failing  to  honour  its  obligations13.  Even  under  this  guarantee  structure,  it 
cannot be completely excluded that the rating of the Stability Bonds could be affected if a 
limited  number  of  AAA-rated  Member  States  would  be  required  to  guarantee  very  large 
liabilities  of  other  lower-rated  Member  States.  There  is  also  a  risk  that  in  an  extreme 
situation a cascade of rating downgrades could be set in motion, e.g. a downgrading of a 
larger  AAA-rated  Member  State  could  result  in  a  downgrading  of  the  Stability  Bond, 
which  could  in  turn  feedback  negatively  to  the  credit  ratings  of  the  other  participating 
Member  States.  Accordingly,  appropriate  safeguards  would  be  essential  to  assure 
budgetary  discipline  among  the  participating  Member  States  via  a  strong  economic 
governance  framework  (and  possibly  seniority  of  Stability  Bonds  over  national  bonds 
under an option where these would continue to exist).  

Box 2: Possible redistribution of funding advantages between Member States  

The risk of moral hazard associated with Stability Bond issuance with joint guarantees might 
be  addressed  by  a  mechanism  to  redistribute  some  of  the  funding  advantages  of  Stability 
Bond issuance between the higher- and lower-rated Member States. Such a mechanism could 

11 

12 
13 

In  this  section,  the  terms several  guarantee  and  joint  and  several guarantee  are  used  in  an  economic 
sense that may not be identical to their legal definitions. 
Such as an EU budget or ECB capital key. 
However,  in  such  circumstances,  participating  Member  States  would  have  a  claim  on  the  defaulting 
Member State. 

EN 

9 

   EN 

 
                                                 
make  the  issuance  of  Stability  Bonds  into  a  win-win  proposition  for  all  euro-area  Member 
States. A stylised example using two Member States can be used to demonstrate:  

EN 

10 

   EN 

 
The  government  debt  of  both  Member  States  amounts  to  about  EUR 2  billion,  but  Member 
State A pays a yield of 2%, while Member State B pays a yield of 5% on national issuance 
with 5-year maturity. Stability Bond issuance would finance both Member States fully, with 
maturity  of  5  years  and  an  interest  rate  of  2%).  The  distribution  of  Stability  Bond  issuance 
would be 50% for each Member State.  

Part of the funding advantage that Member State B would enjoy from Stability Bond issuance 
could be redistributed to Member State A. For example, a 100bps discount for Member State 
A  could  be  financed  from  the  300  bps  premium  for  Member  State  B.  Accordingly,  the 
Stability Bond could fund Member  State A  at  a  yield of 1% and fund  Member State B at a 
yield  of  3%.  Both  Member  States  would  have  lower  funding  costs  relative  to  national 
issuance.  

Needless  to  say,  the  mechanism  for  internal  distribution  of  the  benefits  from  Stability 
Issuance would need to be formulated but would be linked to relative budgetary performance 
in the context of the euro-area economic governance framework.  

1.3.2.  Ensuring consistency with the EU Treaty  

Consistency with the EU Treaty would be essential to ensure the successful introduction 
of the Stability Bond. Firstly, Stability Bonds must not be in breach of the Treaty prohibition 
on the “bailing out” of Member States. The compatibility of Stability Bonds with the current 
Treaty framework depends on the specific form chosen. Some options could require changes 
in  the  relevant  provisions  of  the  Treaty.  Article 125  of  the  Treaty  on  the  functioning  of  the 
European  Union  (TFEU)  prohibits  Member  States  from  assuming  liabilities  of  another 
Member State.  

Issuance of Stability Bonds under joint and several guarantees would a priori lead to a 
situation where the prohibition on bailing out would be breached. In such a situation, a 
Member State would indeed be held liable irrespective of its 'regular' contributing key, should 
another  Member  State  be  unable  to  honour  its  financial  commitments.  In  this  case,  an 
amendment  to  the  Treaty  would  be  necessary.  This  could  be  made  under  the  simplified 
procedure  if  a  euro  area  common  debt  management  office  were  constructed  under  an  inter-
governmental framework, but would most likely require the use of the ordinary procedure if it 
were placed directly under EU law since it would extend the competences of the EU. Unless a 
specific basis is established in the Treaty, an EU-law based approach would probably require 
the use of Article 352 TFEU, which implies a unanimous vote of the Council and the consent 
of  the  European  Parliament.  The  issuance  of  Stability  Bonds  and  the  tighter  economic  and 
fiscal coordination needed for ensuring its success would also most likely require significant 
changes to national law in a number of Member States14.  

Issuance  of  Stability  Bonds  under  several  but  not  joint  guarantees  would  be  possible 
within the existing Treaty provisions. For example, increasing substantially the authorised 
lending volume of the ESM and changing the lending conditions with a view to allowing it to 
on-lend  the  amounts  borrowed  on  the  markets  to  all  euro-area  Member  States  could  be 
constructed in a way compatible with Article 125 TFEU, provided the pro-rata nature of the 
contributing key attached to the ESM remains unchanged. The same reasoning would apply to 

14 

For  example,  the  German  Constitutional  Court  ruling  of  7  September  2011  prohibits  the  German 
legislative body to establish a permanent mechanism, "which would result in an assumption of liability 
for  other  Member  States'  voluntary  decisions,  especially  if  they  have  consequences  whose  impact  is 
difficult  to  calculate."  It  also  requires  that  also  in  a  system  of  intergovernmental  governance,  the 
Parliament must remain in control of fundamental budget policy decisions. 

EN 

11 

   EN 

 
                                                 
issuances  of  a  possible  common  debt  management  office,  whose  liabilities  would  remain 
limited to a strictly pro-rata basis. 

The  Treaty  would  also  need  to  be  changed  if  a  significantly  more  intrusive  euro-area 
economic  governance  framework  was  to  be  envisaged.  Depending  on  the  specific 
characteristics  of  Stability  Bonds,  fiscal  and  economic  governance  and  surveillance  in 
participating  Member  States  would  have  to  be  reinforced  to  avoid  the  emergence  of  moral 
hazard.  Further  qualitative  changes  in  governance  beyond  the  proposals  included  in  the 
23 November package will probably require changes in the Treaty. Section 3 discusses such 
options of reinforced fiscal governance in more depth.  

2. 

OPTIONS FOR ISSUANCE OF STABILITY BONDS 

Many possible options for issuance of Stability Bonds have been proposed, particularly 
since the onset of the euro-area sovereign crisis. However, these options can be generally 
categorised  under  three  broad  approaches,  based  on  the  degree  of  substitution  of  national 
issuance  (full  or  partial)  and  the  nature  of  the  underlying  guarantee  (joint  and  several  or 
several) implied. The three broad approaches are15:  

(1) 

(2) 

(3) 

the full substitution of Stability Bond issuance for national issuance, with joint and 
several guarantees;  

the  partial  substitution  of  Stability  Bond  issuance  for  national  issuance,  with  joint 
and several guarantees; and  

the partial substitution of Stability Bond issuance for national issuance, with several 
but not joint guarantees.  

In  this  section,  each  of  the  three  approaches  is  assessed  in  terms  of  the  benefits  and 
preconditions outlined in Section 1.  

2.1. 

Approach  No.  1:  Full  substitution  of  Stability  Bond  issuance  for  national 
issuance, with joint and several guarantees  

Under  this  approach,  euro-area  government  financing  would  be  fully  covered  by  the 
issuance  of  Stability  Bonds  with  national  issuance  discontinued.  While  Member  States 
could  issue  Stability  Bonds  on  a  decentralised  basis  via  a  coordinated  procedure,  a  more 
efficient  arrangement  would  imply  the  creation  of  a  single  euro-area  debt  agency16.  This 
centralised  agency  would  issue  Stability  Bonds  in  the  market  and  distribute  the  proceeds  to 
Member  States  based  on  their  respective  financing  needs.  On  the  same  basis,  the  agency 
would service Stability Bonds by gathering interest and principal payments from the Member 
States. The Stability Bonds would be issued under joint and several guarantees provided by all 
euro-area Member States, implying a pooling of their credit risk. Given the joint-and-several 
nature  of  guarantees,  the  credit  rating  of  the  larger  euro-area  Member  States  would  most 
likely  dominate  in  determining  the  Stability  Bond  rating,  suggesting  that  a  Stability  Bond 
issued  today  could  be  expected  to  have  a  high  credit  rating.  Nevertheless,  the  design  of  the 
cross-guarantees embedded in Stability Bonds and the implications for credit rating and yields 
would need to be more thoroughly analysed.  

15 

16 

A  fourth  approach  involving  full  substitution  of  Stability  Bonds  and  several  but  not  joint  guarantees 
would also be possible but is not considered, as it would not be materially different from the existing 
issuance arrangements. In addition, hybrid cases could be conceived, for example several guarantees on 
debt obligations coupled with a limited joint guarantee to cover short-term liquidity gaps.  
See  section 4  for  a  review  of  the  advantages  and  disadvantages  of  centralised  and  decentralised 
issuance. 

EN 

12 

   EN 

 
                                                 
This  approach  would  be  most  effective  in  delivering  the  benefits  of  Stability  Bond 
issuance. The full substitution of Stability Bond issuance for national issuance would assure 
full  refinancing  for  all  Member  States  irrespective  of  the  condition  of  their  national  public 
finances. In this way, the severe liquidity constraints currently experienced by some Member 
States  could  be  overcome  and  the  recurrence  of  such  constraints  would  be  avoided  in  the 
future.  This  approach  would  also  create  a  very  large  and  homogenous  market  for  Stability 
Bonds, with important advantages in terms of liquidity and reduced liquidity risk premia. The 
new Stability Bonds would provide a common euro-area benchmark bond and so offer a more 
efficient  reference  framework  for  the  pricing  of  risk  throughout  the  euro-area  financial 
system. By assuring high quality government-related collateral for financial institutions in all 
Member  States,  it  would  maximise  the  benefits  of  common  issuance  in  improving  the 
resilience  of  the  euro-area  financial  system  and  in  improving  monetary-policy  transmission. 
The Stability Bond under this approach would also provide the global financial system with a 
second safe-haven market of a size and liquidity comparable with the US Treasury market and 
so would be most effective in promoting the international role of the euro. 

At  the  same  time,  this  approach  would  involve  the  greatest  risk  of  moral  hazard. 
Member States could effectively free ride on the discipline of other Member States, without 
any  implications  for  their  financing  costs.  Accordingly,  this  approach  would  need  to  be 
accompanied  by  a  very  robust  framework  for  delivering  budgetary  discipline,  economic 
competitiveness  and  reduction  of  macroeconomic  imbalances  at  the  national  level.  Such  a 
framework  would  require  a  significant  further  step  in  economic,  financial  and  political 
integration  compared  with  the  present  situation.  Without  this  framework,  however,  it  is 
unlikely that this ambitious approach to Stability Bond issuance would result in an outcome 
that  would  be  acceptable  to  Member  States  and  investors.  Given  the  joint-and-several 
guarantees for the Stability Bond and the robustness required in the underlying framework for 
budgetary discipline and economic competitiveness, this approach to Stability Bond issuance 
would almost certainly require Treaty changes.  

Under this approach, the perimeter of government debt to be issued via Stability Bonds 
would  need  to  be  defined.  In  several  Member  States,  bonds  are  not  only  issued  by  central 
governments but also by regional or municipal governments17. In principle, one might opt for 
including sub-national issuance. The obvious advantage would be that the potential benefits in 
terms  of  market  stability,  liquidity  and  integration  would  be  broadened.  It  would  also  be 
consistent  with  the  EU  approach  to  budgetary  surveillance,  which  covers  the  entire  general 
government  debt  and  deficits.  On  the  other  hand,  pooling  issuance  only  of  central 
governments  might  deliver  a  more  transparent  and  secure  arrangement.  Central  government 
data  are  typically  more  easily  accessed,  which  is  not  always  the  case  for  local  authorities. 
Moreover,  the  issuance  would  cover  only  deficits  fully  controlled  by  central  governments. 
From a purely market point of view, such Stability Bonds would replace only widely known 
central  government  bonds,  which  would  facilitate  the  assessment  and  valuation  of  the  new 
Stability Bonds18.  

The  process  for  phasing-in  under  this  approach  could  be  organised  in  different  ways 
depending  on  the  desired  pace  of  introduction.  Under  an  accelerated  phasing-in,  new 
issuances would be entirely in the form of Stability Bonds and outstanding government bonds 
could be converted into new Stability Bonds, i.e. in form of a switch of a certain amount of 
national government bonds in exchange for new Stability Bonds. The main advantage of this 

17 
18 

This is the case in particular for Germany and to a lesser extent for Spain and France. 
This narrow coverage of Stability Bonds would imply that Member States would have to commit not to 
issue own national, or other sovereign, bonds, including their sub-federal entities if these are included in 
the system of joint issuance. 

EN 

13 

   EN 

 
                                                 
option would be the almost immediate creation of a liquid market with a complete benchmark 
yield  curve.  The  buy-back  of  legacy  bonds  could  also  alleviate  the  current  acute  financing 
problems of the Member States with high debt and high interest rates. However, the operation 
may be complicated and would require careful calibration of the conversion rate to minimise 
market  disruption.  An  alternative  would  be  a  more  gradual  scheme,  i.e.  full,  or  even  only 
partial, new gross issuance for each Member States in Stability Bonds while outstanding euro-
area  government  bonds  would  remain  in  circulation  on  the  secondary  market.  This  would 
allow  the  market  to  gradually  become  accustomed  to  the  new  instrument  and  develop 
analytical/pricing  tools,  thereby  posing  less  risk  of  market  disruption.  However,  in  this 
variant,  building  a  complete  Stability  Bond  market  would  take  several  years  (depending  on 
maturities  of  outstanding  bonds),  delaying  possible  benefits.  As  for  the  outstanding  legacy 
bonds, this segment would be gradually declining, as being replaced by Stability Bonds and 
newly issued national bonds. Hence, the overall liquidity of that segment would decline over 
time and accordingly, the liquidity premium on legacy bonds might gradually rise. 

Due to the need for changes to the Treaty the implementation of this approach might take a 
considerable amount of time. 

2.2. 

Approach  No.  2:  Partial  substitution  of  national  issuance  with  Stability  Bond 
issuance with joint and several guarantees 

Under  this  approach,  Stability  Bond  issuance  would  be  underpinned  by  joint  and 
several  guarantees,  but  would  replace  only  a  limited  portion  of  national  issuance.  The 
portion of issuance not in Stability Bonds would remain under respective national guarantees. 
This  approach  to  common  issuance  has  become  known  as  the  “blue-red  approach”19. 
Accordingly, the euro area sovereign bond market would consist of two distinct parts: 

–  Stability Bonds (or "blue bonds"): The issuance of Stability Bonds would occur only up to 
certain predefined limits and thereby not necessarily covering the full refinancing needs of 
all Member States. These bonds would benefit from a joint-and-several guarantee and 
would imply a uniform refinancing rate for all Member States20.  

–  National  government  bonds  ("red  bonds").  The  remainder  of  the  issuance  required  to 
finance  Member  State  budgets  would  be  issued  at  the  national  level  under  national 
guarantees. In consequence, national bonds would, at least de facto, be junior to Stability 
Bonds  because  of  the  latter's  coverage  by  joint-and-several  guarantees21.  The  scale  of 
national  issuance  by  each  Member  State  would  depend  on  the  agreed  scale  of  common 
issuance  of  Stability  Bonds  and  its  overall  refinancing  needs.  Depending  on  the  size  of 
these residual national bond markets and issuances and the country's credit quality, these 
national  bonds  would  have  country-specific  liquidity  and  credit  features  and  accordingly 
different market yields, also since most sovereign credit risk would be concentrated in the 

19 

20 

21 

See Delpla, J. and von Weizsäcker, J. (2010). They proposed a debt ceiling of 60% of GDP, motivated 
by the Maastricht criteria. 
As in Approach No. 1, Stability Bond issuance could be conducted on a decentralised basis, but would 
probably be more efficiently managed by a central debt management agency. 
Such  a  subordinate  status  of  national  bonds  could  only  apply  to  newly  issued  national  bonds,  i.e. 
national  bonds  issued  after  the  introduction  of  Stability  Bonds.  Conversely,  outstanding  "old"  or 
"legacy" national bonds would have to enjoy the same status as Stability Bonds, because a change of 
their status would, technically, amount to a default. 

EN 

14 

   EN 

 
                                                 
national  bonds,  amplifying  the  credit  risk22.  The  intensified  market  pressures  on  national 
issuance would provide market discipline.  

A key issue in this approach would be the specific criteria for determining the relative 
proportions of Stability Bond and national issuance. The main options would be:  

–  A  simple  rule-based  system:  For  example,  each  Member  State  could  be  entitled  to  an 
amount of Stability Bonds equal to a specified percentage of its GDP, perhaps reflecting 
the Treaty criterion of 60%. An important dimension to consider is how much risk would 
be concentrated on the national (and junior) part, this being dependent on the size of the 
common  issuance  (the  higher  the  share  of  Stability  Bond  issuance,  the  more  risk  is 
concentrated on the residual national issuance). To avoid excessive credit risk in national 
issuance,  while  still  delivering  liquidity  benefits  through  common  issuance,  it  might  be 
appropriate to set the ceiling at a more prudent level.  

–  A more flexible system linked to policy compliance:  The maximum  amount of  a Member 
State's Stability Bond issuance could be fixed as above, but the ceiling at any point in time 
would be linked to the Member State's compliance with rules and recommendations under 
the euro-area governance framework. Non-compliance could be sanctioned by a (possibly 
automatic)  lowering  of  the  respective  Stability  Bond  debt  ceiling  for  the  Member  State 
concerned  (see  also  Section 3).  This  system  would  also  serve  as  a  quasi-automatic 
stabilizer  of  the  credit  quality  of  the  Stability  Bonds,  as  the  respective  share  of  fiscally 
underperforming Member States would be reduced.  

The  credibility  of  the  ceiling  for  the  Stability  Bond  issuance  would  be  a  key 
consideration.  Once  the  blue  bond  allocation  is  exhausted,  the  financing  costs  for  the 
Member State could increase substantially. This could result in political pressures to increase 
the ceiling. Unless there are strong safeguards against such pressures, anticipation of a "soft" 
ceiling  could  largely  eliminate  the  disciplining  effects  of  the  blue-red  approach.  Therefore, 
irrespective of the criteria established for determining the ceiling for Stability Bond issuance, 
it  would  be  essential  that  that  this  ceiling  should  be  maintained  and  not  adjusted  on  an 
arbitrary basis, e.g. in response to political pressure.  

This  approach  to  Stability  Bond  issuance  is  less  ambitious  than  the  full-issuance 
approach above and so delivers less in terms of economic and financial benefits. Due to 
their seniority over the national bonds and guarantee structure, the Stability Bonds would pose 
a very low credit risk, the latter reflected in high credit ratings (i.e. AAA). The yield on the 
Stability  Bonds  would  therefore,  be  comparable  with  yields  on  existing  AAA  government 
bond  in  the  euro  area.  In  consequence,  there  would  be  corresponding  benefits  in  terms  of 
euro-area  financial  stability,  monetary  policy  transmission  and  the  international  role  of  the 
euro, although these would be less than under the more ambitious approach of full substitution 
of  Stability  Bond  issuance  for  national  issuance.  As  the  build-up  phase  in  Stability  Bond 
issuance  toward  the  agreed  ceiling  would  most  likely  take  several  years,  all  Member  States 
could,  during  the  start-up  phase,  have  very  broad  access  to  financial  markets  via  Stability 
Bonds. This would overcome possible liquidity constraints faced by some Member States but 
for  that  period  give  rise  to  the  same  moral  hazard  implications  as  discussed  in  Section 2.1 
under  full  issuance.  Given  that  a  return  to  national  issuance  for  these  latter  Member  States 
would  be  required  when  the  Stability  Bond  ceiling  would  be  reached,  they  would  need  to 
provide reassurance that during this time they would undertake the budgetary adjustments and 
structural reforms necessary to reassure investors and so maintain access to markets after the 

22 

Delpla and von Weizsäcker argue that, due to the high default risk, red debt should largely be kept out 
of the banking system, by becoming no longer eligible for ECB refinancing operations and subject to 
painful capital requirements in the banking system. 

EN 

15 

   EN 

 
                                                 
introductory period. The yields on the newly issued national bonds would, however, rise due 
to  their  junior  status.  Ultimately,  assuming  a  reasonably  high  proportion  of  Stability  Bond 
issuance has been reached, the market would be expected to be liquid, but less liquid than if 
all issuances were in Stability Bonds as the residual national bonds would also hold a certain 
market share. 

On  the  other  hand,  the  preconditions  for  Stability  Bond  issuance  would  be  somewhat 
less binding under this approach. Establishing a ceiling for Stability Bond issuance would 
help to reduce moral hazard by maintaining a degree of market discipline through the residual 
national  issuance.  However,  the  relationship  between  moral  hazard,  market  discipline,  and 
contagion risk in determining the appropriate Stability Bond ceiling is not straightforward. A 
relatively low Stability Bond ceiling (implying a large amount of residual national issuance) 
would  limit  moral  hazard  but  could  leave  Member  States  with  existing  high  debt  levels 
vulnerable  to  the  risk  of  catastrophic  default  on  their  national  issuance.  Such  a  catastrophic 
default  would  carry  contagion  risk  for  the  euro  area  as  a  whole.  A  relatively  high  Stability 
Bond ceiling (implying a small amount of residual national issuance) would imply a greater 
risk  of  moral  hazard  but  would still allow the possibility of default in a Member State  with 
less catastrophic effects and less contagion risk for euro area as a whole. A robust framework 
for maintaining fiscal discipline and economic competitiveness at national level would still be 
required to underpin the Stability Bond issuance, although the market discipline provided via 
the  retention  of  national  issuance  might  imply  a  less  dramatic  transfer  of  sovereignty  than 
under  the  approach  of  full  Stability  Bond  issuance.  Meanwhile,  the  choice  of  ceiling  would 
also determine the likely credit quality of the Stability Bond. A relatively low ceiling would 
underpin the credit quality of Stability Bonds by limiting the amount of debt covered by the 
stronger joint and several guarantees23. The joint-and-several guarantee for the Stability Bond 
would almost certainly require Treaty changes. 

The  process  for  phasing-in  under  this  approach  could  again  be  organised  in  different 
ways  depending  on  the  desired  pace  of  introduction.  Under  an  accelerated  phasing-in,  a 
certain  share  of  outstanding  euro-area  government  bonds  would  be  replaced  by  Stability 
Bonds  at  a  pre-specified  date  using  pre-specified  factors.  This  would  rapidly  establish  a 
critical mass of outstanding Stability Bonds and a sufficiently liquid market with a complete 
benchmark yield curve. However, it could imply that most Member States reach the ceilings 
at the moment of the switch and that they would have to continue tapping capital markets with 
national bonds. Under current market conditions, this might constitute a drawback for some 
Member States. Under a more gradual phasing-in, all (or almost all) new gross issuance for 
Member States would be in Stability Bonds until the Stability Bond issuance target ceiling is 
reached.  Since  for  several  years  only  (or  nearly only)  Stability  Bonds  would  be  issued,  this 
approach would help to ease market pressure and give vulnerable Member States time for the 
reforms  to  take  effect.  However,  specific  challenges  emerge  for  the  transition  period,  as 
highly  indebted  countries  typically  have  larger  and  more  frequent  rollovers.  Unless  other 
arrangements are agreed, their debt replacement with Stability Bonds up to the ceiling will be 
more  rapid  than  the  average,  while  for  countries  with  debt  below  the  ceiling,  it  would  take 
longer. In consequence, the individual risk, which a possible "joint-and-several" guarantee is 
covering, would be skewed to the higher side in the transition phase, while on the other side 

23 

The proposal by Bruegel sets the ceiling at 60% of GDP, using the Maastricht criterion as reference but 
other proposals with even lower ceilings have been made. Indeed, it has been argued that a sufficiently 
low ceiling virtually guarantees zero default risk on Eurobonds. A standard assumption in the pricing of 
default risks is that in the case of default 40% of the debt can be recovered. Applying this consideration 
to  sovereign  debt,  a  ceiling  below  the  recovery  value  would  imply  that  the  debt  issued  under  the 
common scheme will be served under any condition. 

EN 

16 

   EN 

 
                                                 
the liquidity effect, which should compensate the AAA countries, would still be small. This 
specificity  may  need  to  be  reflected  in  the  governance  arrangements.  For  example,  an 
alternative could be to set annual predefined ceilings, rising slowly from zero to the desired 
long-term value.  

Due  to  the  need  for  changes  to  the  Treaty,  the  implementation  of  this  approach  might  also 
take, as for Approach No 1, some considerable time, although the lesser degree of necessary 
changes  to  economic  and  fiscal  governance,  due  to  the  partial  reliance  of  markets  for 
signalling  and  disciplining,  might  make  the  implementation  process  less  complex  and  time-
consuming. 

Box 3: Debt redemption pact and safe bonds  

As  a  specific  example  of  the  partial  issuance  approach,  the  German  Council  of  Economic 
Experts (GCEE) presented in their Annual Report 2011/1224 a proposal for safe bonds that is a 
part  of  a  euro-area  wide  debt  reduction  strategy  aimed  at  bringing  the  level  of  government 
indebtedness back below the 60% ceiling as put in the Maastricht Treaty.  

One  of  the  pillars  of  the  strategy  is  a  so-called  debt  redemption  fund.  The  redemption  fund 
would  pool  government  debt  exceeding  60%  of  individual  countries'  GDP  of  euro  area 
Member States. It would be based on joint liability. Each participating country would, under a 
defined a consolidation path, be obliged to autonomously redeem the transferred debt over a 
period of 20 to 25 years. The joint liability during the repayment phase means that safe bonds 
would  thereby  be  created.  In  practice,  the  redemption  fund  would  issue  safe  bonds  and  the 
proceeds would be used by participating countries to cover their pre-agreed current financing 
needs  for  the  redemption  of  outstanding  bonds  and  new  borrowing.  Therefore,  the  debt 
transfer would occur gradually over around five years. Member States with debt above 60% 
of GDP would therefore not have to seek financing on the market during the roll-in phase as 
long  as  the  pre-agreed  debt  reduction  path  was  adhered  to.  After  the  roll-in  phase,  the 
outstanding  debt  levels  in  the  euro  area  would  comprise:  (i) national  debt  up  to  60%  of  a 
country's GDP, and (ii) debt transferred to the redemption fund amounting to the remainder of 
the debt at the time of transfer. Open questions remain, for example on the fund's risk, and the 
impact on the de facto seniority from collateralisation of the fund's bonds. 

The GCEE debt redemption pact combines (temporary) common issuance and strict rules on 
fiscal adjustment. They do not constitute a proposal for Stability Bonds in the meaning of this 
Green  Paper,  in  the  sense  that  common  issuance  would  be  temporary  and  used  only  for 
Member  States  with  public  debt  ratios  above  60%  of  GDP.  Instead,  the  GCEE  proposes  to 
introduce a temporary financing tool that would give all euro-area Member States time, and 
financial breathing space, to bring their debt below 60% of GDP. Once this goal is reached 
the  fund  and  safe  bonds  will  be  automatically  liquidated.  Therefore,  safe  bonds  are  a  crisis 
tool  rather  than  a  way  of  permanent  integration  of  the  euro-area  government  bond  markets. 
Even  though  temporary,  the  debt  redemption  pact  could  contribute  to  the  resolution  of  the 
current debt overhang problem.  

24 

Published on 9 Nov. 2011, http://www.sachverstaendigenrat-wirtschaft.de/aktuellesjahrsgutachten.html, 
paragraphs 9-13 and 184-197. 

EN 

17 

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2.3. 

Approach  No.  3:  Partial  substitution  of  national  issuance  with  Stability  Bond 
issuance with several but not joint guarantees 

Under this approach, Stability Bonds would again substitute only partially for national 
issuance  and  would  be  underpinned  by  pro-rata  guarantees  of  euro-area  Member 
States25. This approach differs from Approach No. 2 insofar as Member States would retain 
liability  for  their  respective  share  of  Stability  Bond  issuance  as  well  as  for  their  national 
issuance. However, issues relating to the split between Stability Bond and national issuance, 
including the choice of ceiling for Stability Bond issuance, would be largely the same.  

This  approach  to  the  Stability  Bond  would  deliver  fewer  of  the  benefits  of  common 
issuance but would also require fewer preconditions to be met. Due to the several, but not 
joint, guarantee, moral hazard would be mitigated. Member States could not issue benefiting 
from  a  possibly  higher  credit  quality  of  other  Member  States.  In  addition,  the  continued 
issuance  of  national  bonds  would  expose  Member  States  to  market  scrutiny  and  market 
judgement that would be an additional, possibly and at times, strong deterrent to irresponsible 
fiscal  behaviour.  While  this  approach  would  be  of  more  limited  use  in  fostering  financial 
market efficiency and stability, it would be more easily and more rapidly deployable. Given 
the several but not joint guarantees, Member States subject to high market risk premia would 
benefit  considerably  less  from  the  creditworthiness  of  low-yield  Member  States  than  in 
Approach  No. 2  and  particularly  than  in  Approach  No. 1.  In  that  sense,  the  possible 
contribution of Approach No. 3 to mitigating a sovereign debt crisis in the euro area and its 
possible implications on the financial sector would be much more limited. However, given the 
possibly  much  faster  implementation  time  of  this  approach,  it  could,  unlike  the  other  two 
approaches possibly help addressing the current sovereign debt crisis.  

The key issue with this approach would be the nature of the guarantee underpinning the 
Stability  Bond.  In  the  absence  of  any  credit  enhancement,  the  credit  quality  of  a  Stability 
Bond underpinned by several but not joint guarantees would at best be the (weighted) average 
of  the  credit  qualities  of  the  euro-area  Member  States.  It  could  even  be  determined  by  the 
credit  quality  of  the  lowest-rated  Member  State,  unless  they  enjoy  credible  seniority  over 
national  issuance  in  the  case  of  all  Member  States  (see  below).  This  could  reduce  the 
acceptance of the instrument among investors and among the higher-rated Member States and 
undermine the benefits of Stability Bonds, notably their resilience in times of financial stress.  

In order to increase acceptance of the Stability Bond under this approach, the quality of 
the  underlying  guarantees  could  be  enhanced.  Member  States  could  provide  seniority  to 
the  debt  servicing  of  Stability  Bonds.  Furthermore,  Member  States  could  provide  collateral, 
such as cash, gold reserves which are largely in excess of needs in most EU countries, as well 
as  earmarking  specific  tax  receipts  to  servicing  of  Stability  Bonds.  More  than  for  approach 
no. 2, where the common part is backed by joint and several guarantees, the feasibility of this 
option  relies  on  the  seniority  status  of  the  common  issuer  and  on  a  prudent  limit  for  the 
common  issuance.  This  points  to  the  need  for  careful  analysis  of  the  implications  of  this 
option for current bonds in circulation, where some negative pledge clauses may exist, and the 
identification of appropriate solutions.  

While  under  normal  conditions,  the  total  cost  of  debt  for  a  country  should  remain 
constant or fall, the marginal cost of the debt would rise. This should help in containing 
moral hazard and prompting budgetary discipline, even in the absence of any particular form 
of  enhanced  governance  or  fiscal  surveillance.  The  Stability  Bond  would  thereby  provide  a 

25 

Such  an  approach  was  considered  in  the  Giovannini  Group  report  (2000)  –  though  through 
decentralised  issuance  and  was  more  recently  proposed  by  De Grauwe  and  Moesen  (2009),  Monti 
(2010) and Juncker and Tremonti (2010). 

EN 

18 

   EN 

 
                                                 
link  and  reinforce  the  effectiveness  of  the  newly  established  governance  package,  if  the 
amounts  to  be  funded  through  common  issuance  are  determined  in  close  connection  with 
fiscal targets established in the Stability programmes and create strong incentives to rapidly 
reduce  overall  debt  levels26.  It  would  also  eliminate  the  need  for  a  Treaty  change  in  this 
regard.  However,  maintaining  the  credit  quality  of  the  Stability  Bond  would  most  likely 
require secondary legislation to establish the seniority status of the Stability Bond.  

The alternatives in the treatment of legacy bonds, as well as their respective advantages 
and disadvantages, would be similar to the ones described under Approach No. 2. 

This option could be implemented relatively quickly. This option could be pursued without 
requiring changes to the EU Treaty, while secondary legislation may be helpful to strengthen 
the seniority principle. Furthermore, substitution of national by Stability Bonds would only be 
partial.  

2.3.1.  Combining the approaches 

As  the  scope,  ambition  and  required  implementation  time  vary  across  the  three 
approaches,  they  could  also  be  combined.  Approach  No. 1  can  be  considered  the  most 
ambitious  approach,  which  would  deliver  the  highest  results  in  market  integration  and 
strengthening stability but it might require considerable time for implementation. Conversely, 
Approach  No. 3,  with  its  different  scope  and  guarantee  structure,  seems  to  be  more  easily 
ready for a more rapid deployment. Hence, there is a certain trade-off between ambition of the 
features  and  scope  of  the  Stability  Bond  and  the  possible  speed  of  implementation.  To 
overcome  this  trade-off,  the  various  options  could  be  combined  as  sequential  steps  in  a 
process of gradual implementation: a relatively early introduction based on a partial approach 
and a several guarantee structure, combined with a roadmap towards further development of 
this instrument and the related stronger governance. Such an upfront political roadmap could 
help ensuring the market acceptance of Stability Bonds from the outset. 

2.3.2. 

Impact on non-euro area Member States of the EU and third countries 

Participation  in  the  Stability  Bond  framework  is  usually  conceived  for  the  Member 
States of the euro area27. This is a due to the normal desire of Member States to issue debt 
and maintain markets in their own currency and of the fact that E-bonds might  be  part of a 
framework of a higher degree of economic and political integration. However, these Member 
States would nevertheless be affected by the introduction of Stability Bonds, accompanied by 
a  reinforced  framework  of  economic  governance.  Financial  stability  across  the  euro  area 
fostered  by  Stability  Bonds  would  also  directly  and  substantially  stabilise  financial  markets 
and institutions in these countries. The same would apply for any third country, to the extent 
of its economic and financial linkages with the euro area. On the other hand, the creation, by 
Stability  Bonds,  of  a  very  large  and  sound  market  for  safe  assets  might  add  to  competition 
between financial markets for investors' interest. 

26 

27 

Similarly,  but  presumably  needing  a  Treaty  change,  Bini-Smaghi  proposed  a  Eurobond  with  pro-rate 
guarantees but with the right to issue debt transferred from Member States to a supra-national agency. 
The debt could be issued up to levels agreed by the Council in the context of the yearly approval of the 
stability  programmes,  which  would  made  impossible  issuing  debt  to  cover  expenditure  over  the  debt 
limit set every year. This way a "debt brake" would be created, which would force a country to make an 
early decision when its public debt gets too close to the agreed limit. 
Even if in particular under approach no. 3 participation by Member States outside the euro area seems 
conceivable. 

EN 

19 

   EN 

 
                                                 
Table 1: Overview over the three main options 

(Option 1) 

(Option 2) 

(Option 3)  

Full 

Partial 

Partial 

Main features 
–  Degree of substitution 
of national issuance 
by Stability Bonds  

–  Guarantee structure  Joint and several 

Joint and several 

Main effects 
–  on average funding 

costs  

1/  for  Stability  Bond 
as a whole 
2/ across countries 

Medium 
effect 
large 

1/ 
positive 
from  very 
liquidity 
compensated 
strong 
hazard.  
2/  Strong  shift  of 
from 
benefits 
higher 
lower 
rated countries 

by 
moral 

to 

–  on possible moral 
hazard (without 
reinforced 
governance) 
–  on financial 

integration in Europe 

–  on global 

attractiveness of EU 
financial markets  
–  on financial market 

stability 

High 

High 

High 

High 

Legal considerations 

Probably  Treaty 
change  

Several  (not  joint)  with 
enhancements 

1/  Medium  positive 
effect,  lower  liquidity 
effect 
sounder 
and 
policies  prompted  by 
market 
enhanced 
discipline  

impact  across 
2/  no 
Stronger 
country. 
market  pressure  on  MS 
with  high  level  of  debt 
and 
subprime  credit 
ratings  
Low, 
incentives 
discipline 

strong  market 
fiscal 

for 

1/  Medium  positive 
effect,  from  medium 
liquidity  and  limited 
moral hazard  
2/  Smaller  shift  of 
benefits  from  higher 
rated 
to 
Some 
countries. 
market  pressure  on 
MS with high level of 
debt  and  subprime 
credit ratings 

lower 

Medium,  but  strong 
market  incentives  for 
fiscal discipline 

Medium 

Medium  

Medium 

Medium 

High, 
some 
but 
challenges  in  case  of 
unsustainable 
levels 
of national issuance 
Probably 
change  

Treaty 

Low, but it may help to 
deal  with  the  current 
crisis thanks to its rapid 
implementation.  
No  Treaty 
required. 
legislation  may 
helpful. 
Short 

changes 
Secondary 
be 

Necessary  minimum 
implementation time  

Long 

Medium to long 

EN 

20 

   EN 

 
 
 
 
 
 
 
 
3. 

FISCAL FRAMEWORK FOR STABILITY BONDS 

3.1. 

Background 

The fiscal surveillance framework has already been strengthened with the recent reform 
of  the  SGP  including  new  enforcement  mechanisms.  Moreover,  it  should  be  further 
reinforced  in  the  near  term,  especially  for  euro-area  Member  States  under  EDP  and/or 
requesting  or  receiving  financial  assistance,  in  line  with  the  recent  conclusions  of  the  euro-
area Heads of States and Governments and the Commission proposal for two new Regulations 
based on Article 136:  

–  the  proposal  for  a  Regulation  on  common  provisions  for  monitoring  and  assessing  draft 
budgetary plans and ensuring the correction of excessive deficit in the euro area Member 
States pursues the triple aim of (a) complementing the European semester with a common 
budgetary  timeline  aiming  at  better  synchronizing  the  key  steps  in  the  preparation  of 
national  budgets;  (b) complementing  the  multilateral  surveillance  system  of  budgetary 
policies (the preventive arm of the SGP) with additional monitoring requirements in order 
to  ensure  that  EU  policy  recommendations  in  the  budgetary  area  are  appropriately 
integrated in the national budgetary preparations and (c) complementing the procedure for 
correction of a Member State's excessive deficit (the corrective arm of the SGP) by a closer 
monitoring of budgetary policies of Member States in excessive deficit procedure in order 
to secure a timely durable correction of excessive deficits;  

–  the  proposal  for  a  Regulation  on  enhanced  surveillance  ensures  that  a  euro  area  Member 
State  should  be  subject  to  enhanced  surveillance  when  it  is  experiencing  -  or  at  risk  of 
experiencing  -  severe  financial  disturbance,  with  a  view  to  ensuring  its  swift  return  to  a 
normal  situation  and  to  protecting  the  other  euro  area  Member  States  against  possible 
negative spill over effects. 

These two new Regulations together with the profound changes stemming from the reform of 
the  SGP  constitute  a  solid  foundation  for  enhanced  coordination  of  budgetary  policy  of  the 
euro area Member States.  

Still, Stability Bonds create risks of moral hazard and require a further strengthening of 
the framework, depending on the chosen option. Three dimensions of such a strengthened 
framework may be identified: 

–  Increased  surveillance  and  intrusiveness  in  the  design  and  implementation  of  national 
fiscal  policies  would  be  warranted  beyond  the  recent  proposals.  Further,  the  servicing  of 
Stability Bonds would be fully assured. 

–  At  the  same  time,  the  very  existence  of  Stability  Bonds  could  fundamentally  alter 
budgetary processes, notably via the allocation mechanisms, and offer a tool to effectively 
enforce a rule-based framework for fiscal policies. 

–  Fiscal conditions could be demanded for entering the system of Stability Bonds, with the 
effect of reinforcing the credibility of both current adjustment plans and at cruising speed.  

3.2. 

Increased surveillance and intrusiveness in national fiscal policies  

The recent and forthcoming reforms of surveillance create a sound basis to limit these 
risks, but more would be needed. Such strengthening of the framework could apply to EU 
surveillance and to national budgetary frameworks.  

In line with currently discussed changes, this would entail more thorough examination 
of  draft  budgets,  not  only  for  fiscally  distressed  countries  but  for  all  participating 

EN 

21 

   EN 

 
Member  States.  EU  approval  of  budgets  could  be  needed  for  participating  Member  States 
under  certain  circumstances  such  as  high  indebtedness  or  deficit  levels.  Moreover,  a  much 
stronger monitoring framework of budgetary execution would be required. This could include 
including  regular  reporting  at  common  budgetary  'rendezvous',  the  development  of  alert 
mechanisms  based  on  fiscal  scoreboards,  and  the  actual  possibility  of  correcting  slippages 
during  execution  –  for  instance  by  explicitly  planning  ex  ante  budgetary  reserves  and 
conditioning the entry into force of costly new measures on on-track execution.  

National  fiscal  frameworks  will  be  strengthened  in  the  relatively  near  term  by  the 
implantation of the Directive on fiscal frameworks (which could in fact be accelerated). 
Furthermore,  there  are  ongoing  discussions  to  go  further,  inter  alia  by  the  introduction  of 
rules translating the SGP framework in national legislation, preferably at constitutional level, 
and  with  adequate  enforcement  mechanisms.  Other  possible  key  reinforcements  of  national 
frameworks  include  the  adoption  of  binding  medium-term  frameworks,  independent  bodies 
assessing  the  underlying  assumptions  of  national  budgets  and  effective  coordinating 
mechanisms between levels of public administration. As regards the latter point, the pooling 
of debt at European level may give additional reason to bring closer the debt management of 
sub-sectors of public administration. 

National frameworks also have an important role to play in supporting surveillance at 
EU level. For example, common timelines in the preparation of budgets would facilitate EU 
surveillance  (and  may  in  fact  be  necessary  to  devise  the  allocation  for  Stability  Bonds  in 
practice).  Similarly,  a  proper  monitoring  of  budget  execution  at  EU  level  hinges  on  sound 
national arrangements to that aim, which could call for the adoption of common standards of 
control and disclosure.  

A system would have to be put in place that credibly ensures the full debt service of each 
Member  State  benefiting  from  the  issuance  of  Stability  Bonds.  This  entails  that  the 
servicing  of  Stability  Bonds,  or  more  specifically  the  payment  of  interest  on  common 
issuance,  should  not  come  under  any  circumstances  into  question.  One  option  to  this  end 
would be to grant extensive intrusive power at EU level in cases of severe financial distress, 
including the possibility to put the failing MS under some form of 'administration'. Another 
option,  as  already  mentioned  in  the  previous  section,  that  would  perhaps  less  infringe  on 
national sovereignty would be to introduce a clause for participating countries on seniority of 
debt  service  in  the  Stability  Bonds  system  over  any  other  spending  in  the  national  budgets. 
Such  rules  would  need  to  have  stringent  legal  force,  presumably  at  constitutional  level.  In 
addition and in accordance to that, obligations towards the Stability Bonds system would have 
to be senior to (remaining) new national emissions if any.  

3.3. 

Stability Bonds as a component of an improved fiscal framework 

While Stability Bonds create risks of moral hazard, they are also likely to change at the 
root the conditions in which budgetary policies are formulated and implemented. This is 
notably  because  European  guidance  on  national  budget  policies  would  be  translated  into 
tangible figures by the very process of setting borrowing allocations to participating Member 
States. Indeed, the functioning of Stability Bonds would  under  all discussed options  require 
devising  ex  ante  ceilings  for  national  borrowing  that  would  then  frame  or  at  least  affect 
national  budgets,  especially  in  case  of  wide-reaching  options  (i.e.  Approach  No 1  above) 
where Stability Bonds would be expected to cover all or the bulk of new financing needs of 
participating  countries.  In  this  perspective,  Stability  Bonds  may  be  regarded  not  only  as  a 
potential  source  of  moral  hazard,  but  also  as  a  driver  of  better  coordination  of  budgetary 
policies through the effective enforcement of a rule-based framework.  

EN 

22 

   EN 

 
If  Stability  Bonds  would  provide  all  or  the  bulk  of  government  finance  (i.e.  Approach 
No. 1)  clear  principles  would  have  to  guide  the  framework  for  allocations  under  the 
Stability Bond scheme:  

(1) 

(2) 

The maximum allocations would have to be based on sufficiently sound fiscal rules, 
with the framework under the SGP offering a natural basis. The rules would thereby 
provide strong incentives for responsible fiscal behaviour. 

These  guidelines  would  have  to  address  the  degree  of  flexibility  to  deal  with 
unexpected  developments  and  to  minimise  the  risk  of  pro-cyclical  policies.  A  key 
question  would  be  whether  fiscal  flexibility  to  respond  to  shocks,  either  country-
specific or at the level of the euro area, would be provided by additional issuance of 
Stability  Bonds  or  would  have  to  rely  on  national  issuance  (provided  they  remain 
possible). The more flexibility is allowed within the system, the higher the need for 
constraining mechanisms (such as control accounts) to ensure that flexibility is kept 
within agreed limits and avoid 'debt creeping'.  

(3) 

The  rules  should  likely  also  incorporate  some  form  of  'graduated  response'  to 
unsound  fiscal  developments.  This  graduation  could  take  the  form  of  reinforced 
surveillance, intrusiveness into national fiscal policies, as envisaged above.  

In addition, financial incentives for sound fiscal policies could be built into the system. 
While yields of Stability Bonds would be market-based, funding costs might be differentiated 
across  Member  States  depending  on  their  fiscal  positions  or  fiscal  policies,  or  their  market 
creditworthiness,  as  reflected  by  the  risk-premium  of  national  issuances  over  common 
issuances.  This  would  provide  an  incentive  for  sound  fiscal  policies  within  the  system  and 
would mimic market discipline though in a smoother, more consistent fashion than markets. 
Such an incentive, which would automatically exist under the 'several guarantee' option, could 
be further enhanced with 'punitive' rates in case of slippages from plans.  

3.4. 

Fiscal conditions for entering the system 

In order to implement the vision of Stability Bonds as "stability bonds" one might also 
set  macro-economic  and  fiscal  conditions  for  Member  States  in  order  to  enter  and 
remain  in  the  system.  For  example,  Member  States  might  be  denied  access  to  Stability 
Bonds  if  they  have  not  respected  their  commitments  under  the  SGP  or  under  a  reinforced 
fiscal framework. Alternatively, Member States in breach of their fiscal targets might have to 
provide  (additional)  collateral  for  new  Stability  Bond  issuance  or  might  be  subject  to  an 
interest  surcharge.  Access  could  also  be  limited  as  a  function  of  the  degree  of  non-
compliance,  i.e.  a  deviation  of  the  general  government  budget  by  each  percentage  point  of 
GDP might reduce the right to issue Stability Bonds by a certain amount of percentage points 
of GDP. 

A number of benefits could be expected from this approach:  

–  First,  to  the  extent  that  they  wish  to  be  included  in  the  Stability  Bonds  system,  Member 
States  would  have  additional  incentives  to  fully  implement  the  consolidation  and  reform 
efforts  they  have  already  engaged  into,  in  a  fashion  not  unlike  the  convergence  efforts 
undertaken in order to adopt the euro.  

–  Second,  financial  markets  and  societies  at  large  would  consider  consolidation  plans  as 
more  credible  given  the  prospect  for  Stability  Bonds.  Thereby,  the  prospect  of  joining 
Stability  Bonds  could  raise  confidence  already  in  the  relatively  near  term.  Such  renewed 
confidence could in fact facilitate fiscal adjustments in some countries.  

EN 

23 

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–  Finally,  strong  fiscal  conditions  for  entry  and  continued  participation  would  be 
instrumental  in  lowering  debt  ratios  and  borrowing  needs  before  the  respective  countries 
participate in the Stability Bonds. In this manner, risk premia and yields of Stability Bonds 
could be lowered.  

Such an approach would imply that Member States would need to maintain residual financing 
possibilities, in case they do not meet these conditions. Hence, the Stability Bond would not 
necessarily replace the entire bond issuance of euro area Member States. One would also have 
to  designate  an  institution  or  body  responsible  to  monitor  the  compliance  with  these  entry 
criteria (for example, but not necessarily, the DMO). 

4. 

IMPLEMENTATION ISSUES 

4.1.1.  Organisational set-up 

A number of technical issues would need to be decided with respect to the organisation 
of  Stability  Bond  issuance.  Most  importantly,  the  institutional  structure  of  funding 
operations  would  need  to  be  determined,  i.e.  whether  a  centralised  debt  management  office 
(DMO)  would  be  established  or  whether  the  essential  functions  could  be  carried  out  in  a 
decentralised way by national Treasuries and DMOs. As regards the decentralised approach, 
issuance would need to be conducted under uniform terms and procedures and would require 
a  high  degree  of  co-ordination.  Whereas  the  centralised  approach  would  avoid  the 
coordination of bond issuances, it would still require the transmission of detailed and reliable 
information on Member States financing needs so that the issuances could be planned. With 
respect to the design of a central issuance agent, several options are conceivable, including: 
(a) the European Commission could serve as DMO, which would allow speedy introduction 
of  the  Stability  Bond  and  allow  the  instrument  to  be  used  to  manage  the  current  crisis;  or 
(b) the EFSF/ESM could be transformed into a full scale DMO; or (c) a new EU DMO could 
be created28, which would require some time to become operational. The exact administrative 
cost of the introduction of Stability Bonds cannot be calculated without all other details being 
defined  in  advance.  Their  magnitude  would  also  have  an  impact  on  the  Member  States 
budgets. 

An important technical issue would be how a centralised DMO would on-lend the funds 
raised to the Member States. In principle, there would be two options, which could also be 
combined: (a) on-lending in the form of direct loans, where the Member State would receive 
its funding through a loan agreement; and (b) the direct purchase of all, or the agreed amount 
of,  government  bonds  from  the  Member  States  by  the  DMO  in  the  primary  market.  The 
second  option  would  allow  the  DMO  to  also  buy  outstanding  government  debt  in  the 
secondary market, if needed.  

The repayment of bonds would also need to be organised. The most straightforward way 
of doing this would be through transfers by the national authorities to the issuing agent that 
would organise the repayment to the bondholders. In order to ensure that market participants 
could  trust  that  the  servicing  of  debt  would  always  be  guaranteed  and  delays  of  payments 
would not occur, the DMO would need to be endowed with a stable and predictable revenue 
stream.  While  Member  States  would  need  to  guarantee  the  liabilities  of  this  body,  it  would 
need  to  be  verified  whether  this  would  be  sufficient  or  whether  additional  collateral,  cash 
buffers might be required. Present national debt management offices are part of the national 
fiscal  institutions,  being  backed  by  the  governments'  authority  to  raise  taxes.  For  a  debt 

28 

In  transition  there  could  be  a  COM  agency  with  COM  staff  and  temporary  national  DMO  staff  that 
could be later transformed in a DMO if necessary.  

EN 

24 

   EN 

 
                                                 
management  office  at  supranational  level,  there  would  not  be  such  a  direct  link  to  tax 
revenues, which might reduce the market's acceptance of the debt instruments to be issued. 

Even  with  Stability  Bonds,  there  would  be  a  need  for  Member  States'  liquidity 
management. It might in practice be nearly impossible to design bond issuance in such a way 
that  it  would  provide  a  perfect  match  of  Member  States'  payment  streams.  Therefore,  there 
would,  be  a  need  to  supplement  Stability  Bond  issuance  with  day-to-day  liquidity 
management,  which  could  be  left  to  the  national  authorities.  One  option  would  be  that  the 
Stability  Bond  issuance  would  focus  on  medium-term  funding  needs  and  that  the  national 
authorities  would  manage  their  payment  profiles  through  short-term  deposits  and  loans  or 
bills.  Irrespective  of  the  organisational  set-up,  procedures  would  need  to  be  developed  to 
coordinate the funding plans of individual Member States, with a view to develop benchmark 
issues and to build a complete benchmark yield curve.  

4.1.2.  Relationship with the ESM 

The setting up of an  agent  for  joint issuance of Stability Bonds for euro area  Member 
States might warrant a clarification of the division of tasks with the European Stability 
Mechanism.  In  principle,  two  main  views  can  be  adopted:  The  ESM  might  be  considered 
materially  redundant,  as  joint  issuance,  coupled  with  reinforced  fiscal  surveillance  rules, 
could assume the role of organising ordinary finance for Member States' governments as well 
as exceptional additional finance in case of serious difficulties of a Member State. However, 
mixing the roles of debt management and emergency financing might be suboptimal and lead 
to  a  confusion  of  roles,  a  weakening  of  incentives  and  governance  and  an  overly  complex 
single funding institution. For this reason, the ESM could remain as a separate issuer of debt 
for the purpose of organising and meeting exceptional financing needs. 

The choice of interaction with the ESM would also depend on the respective option for 
Stability Bonds. The ESM could be considered fairly redundant in case of Approach No. 1 
for Stability Bonds. Under this approach, that foresees nearly full coverage of financing needs 
by  Member  States,  also  exceptional  additional  financing  needs  could  be  provided.  The 
situation seems much less clear in the case of Approaches Nos. 2 and 3, under which Member 
States would continue to issue national bonds in parallel to joint issuance of Stability Bonds. 
One  might  even  contemplate  to  use  the  ESM  framework  for  first  steps  towards  Stability 
Bonds.  As  the  ESM  will  be  based  on  several  guarantees  by  Member  States,  the  gradual 
introduction  of  Stability  Bonds  based  on  several  (but  not  joint)  guarantee,  i.e. based  on 
Approach No. 3, could be encompassed by ESM financing and issuance that would go beyond 
the  current  role  of  providing  exceptional  financial  assistance.  In  principle,  joint  and  several 
guarantees could be applied to the ESM at a later stage.  

4.1.3.  Legal regime governing issuance 

Consideration must also be given to the appropriate legal regime under which Stability 
Bonds  would  be  issued.  Currently,  government  bonds  are  issued  under  domestic  law.  For 
international bond issuances, English law or, if the US market is targeted, New York law is 
often  used.  An  equivalent  EU  law,  under  which  Stability  Bonds  could  be  issued,  does  not 
exist. Although it is common practice to rely on foreign law for international bond issuances, 
there may be a problem if all government debt was covered by UK or US law, because the 
Anglo-Saxon  case-law  approach  is  different  from  the  legal  system  in  many  Member  States. 
The relevant court would also need to be agreed upon. 

4.1.4.  Documentation and market conventions 

A decision on funding options, security characteristics and market conventions would be 
needed.  For  an  established  issuer,  auctions  would  be  the  preferred  option  for  issuance. 

EN 

25 

   EN 

 
Syndication  has  the  advantage  that  the  financial  industry  is  involved  in  marketing  the 
instruments  and  the  pricing  of  a  security  is  more  predictable.  In  addition,  typically  larger 
amounts may be placed via syndication as it reaches also retail-investors. In addition, various 
security  characteristics  and  market  conventions  would  need  to  be  determined.  The  most 
important ones of these are addressed in Annex 4.  

4.1.5.  Accounting issues 

An  additional  issue  in  need  of  further  clarification  is  the  treatment  of  Stability  Bonds 
under national accounting rules. In particular, the question of how the national debt-to-GDP 
ratios would be affected by Stability Bonds under the different guarantee structures needs to 
be explored. An important issue of consideration will be the nature of any new issuing entity.  

5. 

CONCLUSIONS AND WAY FORWARD 

The  common  issuance  of  Stability  Bonds  by  euro  area  Member  States  has  significant 
potential benefits. These include the deepening of the internal market and rendering capital 
markets more efficient, increasing the stability and shock resilience of the financial sector and 
of government financing, raising the attractiveness of euro area financial markets and the euro 
at  global  level,  and  reducing  the  impact  of  excessive  market  pessimism  on  sovereign 
borrowing costs.  

However,  the  introduction  of  Stability  Bonds  is  also  associated  with  significant 
challenges. These must be convincingly addressed if the benefits are to be fully realised and 
potential  detrimental  effects  avoided.  In  particular,  a  sufficiently  robust  framework  for 
budgetary discipline and economic competiveness at the national level and a more intrusive 
control of national budgetary policies by the EU would be required, in particular for options 
with  joint  and  several  guarantees  to  limit  moral  hazard  among  euro-area  Member  States, 
underpin the credit quality of the Stability Bond and assure legal certainty.  

The  many  options  for  common  issuance  of  Stability  Bonds  can  be  categorised  in  three 
broad approaches. These  approaches imply  the full substitution of Stability Bond issuance 
for  national  issuance  under  a  joint  and  several  guarantees,  a  partial  substitution  of  Stability 
Bond  issuance  for  national  issuance  under  similar  guarantees  and  a  partial  substitution  of 
Stability Bond issuance for national issuance under several guarantees. These options present 
different trade-offs between the expected benefits and pre-conditions to be met. 

In particuar due to different degrees of required changes to the EU Treaty (TFEU), the 
various  options  would  require  different  degrees  of  implementation  time.  The  most  far-
reaching  Approach  No  1  would  seem  to  require  the  most  far-reaching  Treaty  changes  and 
administrative  preparations  both  because  of  the  introduction  of  the  common  bonds  as  such 
and  the  parallel  strengthening  of  economic  governance.  Approach  No  2  would  also  require 
considerable lead-time. In contrast, Approach No 3 would seem feasible without major Treaty 
changes and therefore less delay in implementation.  

The suggestions and findings in this paper are still of exploratory nature and the list of 
issues  to  be  considered  is  not  necessarily  exhaustive.  Furthermore,  many  of  the  potential 
benefits  and  challenges  are  presented  only  in  qualitative  terms.  A  detailed  quantification  of 
these  various  aspects  would  be  intrinsically  difficult  and/or  will  require  more  analysis  and 
input from various sides. Also, in many instances, the problems to be resolved or decisions to 
be taken are identified but not resolved.  

In  order  to  advance  on  this  issue,  more  analytical  work  and  consultation  are 
indispensable.  Several  of  the  key  concepts,  possible  objectives  and  benefits,  requirements 

EN 

26 

   EN 

 
and implementation challenges merit a more detailed consideration and analysis. The views of 
key stakeholders in this respect are essential. In particular, Member States, financial market 
operators, financial market industry associations, academics, within the EU and beyond, and 
the  wider  public  should  be  adequately  consulted.  The  results  of  this  consultation  should  be 
reflected in the further follow-up of the potential launching of Stability Bonds. 
Accordingly, the Commission has decided to launch a broad consultation29 on this Green 
Paper, which will close on [8 January 2012]30. The Commission will seek the views of all 
relevant stakeholders as mentioned above and seek the advice of the other institutions. On the 
basis of this feedback, the Commission will indicate its views on the appropriate way forward 
by [mid February 2012].  

29 

30 

Feedback can be provided via all normal means, including to a dedicated mailbox: 
ECFIN-Green-Paper-Stability-Bonds@ec.europa.eu; 
(webpage: http://ec.europa.eu/economy_finance/consultation/index_en.htm). 
For  the  sake of  a  timely  follow  up,  the  deviation  from  the normal  consultation period of  eight weeks 
seems  justified  by  the  fact  that  the  concept  of  Stability  Bonds/Eurobonds  has  already  been  widely 
discussed for a considerable amount of time.  

EN 

27 

   EN 

 
                                                 
 
Annex 1: Basic figures on government bond markets 

Member 
State 

General government  
debt 

Central 
government 
debt 

Govern-
ment bond 
yields 

CDS 
spreads 

Credit 
rating 

EUR 
billion, 
end 2010 

% of 
GDP, 
end 2010 

% of 
euro area, 
end 2010 

% of GDP, 
end 2010 

% p.a., 
10 years, 
8/11/2011 

Basis points 
p.a.; 5-year 
contracts, 
8/11/2011 

Standard 
& Poor's, 
8/11/2011 

87.7 

53.2 

3.3 

4.3 

1.8 

n.a. 

155.6 

27.8 

Italy 

1842.8 

118.4 

23.6 

111.7 

102.6 

10.1 

Belgium 

340.7 

96.2 

4.4 

Germany 

2061.8 

83.2 

26.4 

Estonia 

1.0 

6.7 

Greece 

329.4 

144.9 

Spain 

641.8 

61 

0.0 

4.2 

8.2 

France 

1591.2 

82.3 

20.3 

Ireland 

148.0 

94.9 

1.9 

Cyprus 

10.7 

61.5 

Luxembourg 

7.7 

19.1 

Malta 

4.3 

69 

Netherlands 

369.9 

62.9 

Austria 

205.6 

71.8 

Portugal 

161.3 

93.3 

Slovenia 

13.7 

38.8 

Slovakia 

27.0 

41 

Finland 

87.0 

48.3 

0.1 

0.1 

0.1 

4.7 

2.6 

2.1 

0.2 

0.3 

1.1 

Euro area 

7822.4 

85.4 

100 

p.i.: USA 

10258 

94.4 

Source: Eurostat, IMF, S&P, Bloomberg 

52.3 

67.8 

94.3 

17.4 

68.9 

57.3 

66.2 

91.2 

37.3 

40.1 

43.9 

71.6 

292.9 

AA+ 

89.3 

AAA 

n.a. 

n.a. 

400.1 

AA- 

CC 

AA- 

183.8 

AAA 

729.7 

BBB+ 

520.7 

A 

n.a. 

n.a. 

n.a. 

99.6 

159.9 

BBB- 

AAA 

A 

AAA 

AAA 

5.6 

3.1 

8.0 

6.8 

n.a. 

n.a. 

2.2 

3.0 

11.6 

1050.9 

BBB- 

6.0 

4.0 

2.3 

n.a. 

2.08 

304.25 

221.2 

AA- 

A+ 

60.63 

AAA 

n.a. 

47.5 

n.a. 

AA+ 

EN 

28 

   EN 

 
 
 
 
 
Annex 2: Concise review of the literature on Stability Bonds 

Academics, financial analysts and policy-makers have published many papers on the idea of 
Eurobonds (Stability Bonds). This annex summarises those contributions published so far, by 
grouping them according to basic features of the proposals.  

–  Credit quality and guarantee structure: Most of the authors emphasise the importance of 
the  safe  haven  status  that  Eurobonds  should  have  and  which  would  be  reflected  by  the 
rating.  The  highest  credit  quality  would  be  secured  mainly  through  guarantee  structure 
and/or  seniority  status.  Two  basic  guarantee  types  to  be  embedded  in  Eurobonds  emerge 
from  the  literature:  (i)  joint  and  several  (Jones,  Delpla  and  von Weizsäcker,  Barclays 
Capital, Favero and Missale, J.P. Morgan) in which each country each year guarantees the 
entire Eurobond issuance and (ii) pro-rata (Juncker and Tremonti, De Grauwe and Moesen, 
BBVA)  in  which  a  country  guarantees  only  a  fixed  share  of  the  issuance.  Favero  and 
Missale  emphasise  that  a  Eurobond  backed  by  joint  and  several  guarantees  could  reduce 
exposure  to  crisis  transmission  and  contagion.  On  the  other  hand,  authors  supporting  the 
pro-rata  guarantee  argue  that  it  reduces  moral  hazard.  Capaldi  combines  a  pro-rata 
guarantee with credit enhancements (cash buffer, over-guarantee, capital, etc) to ensure the 
highest  credit  rating.  Delpla  and  Weizsäcker,  Barclays  Capital,  Dübel  propose  to  ensure 
the  credit  quality  of  Eurobonds  by  making  them  superior  to  national  bonds,  arguing  that 
even in the extreme case of a sovereign default the recovery value would be high enough to 
fully  serve  the  senior  bonds.  Dübel  presents  a  slightly  different  approach  of  partial 
insurance of sovereign (senior) bonds by the ESM.  

–  Moral  hazard:  Moral  hazard  due  to  weaker  incentives  for  fiscal  discipline  is  the  main 
argument  used  against  Stability  Bonds  and  the  most  widely  discussed  issue  in  all  the 
proposals  (in  particular  by  Issing).  Some  authors  propose  limits  on  the  volume  of 
Eurobonds issued on behalf of Member States, often following the debt ceiling of 60% as 
defined in the SGP. Any additional borrowing needs should be financed by national bonds. 
This  idea  is  explored  in  the  Blue  bond  concept  by  Delpla  and  von  Weizsäcker,  which 
suggests  a  split  of  the  issuance  between  Blue  bonds,  i.e.  extremely  liquid  and  safe 
(guaranteed jointly and severally by participating countries) bonds with senior status, and 
Red  bonds  -  purely  national  with  junior  status.  The  pricing  of  red  bonds  would  create 
incentives for governments to keep the budget under control. In a similar vein, Jones and 
Barclays  Capital's  propose  limits  both  on  debt  and  on  deficits  that  would  allow  for  a 
gradual decline of  debt-to-GDP ratios. In addition to limiting the issuance of Eurobonds, 
Favero  and  Missale  propose  to  address  moral  hazard  through  a  compensation  scheme 
based  on  the  indexation  of  the  interests  paid  by  each  Member  State  (as  a  function  of  its 
credit risk premium or fiscal parameters). Boonstra, De Grauwe and Moesen, BBVA and 
Natixis propose various types of a bonus/penalty system depending e.g. on the capacity of 
different Member States to reduce their general government deficit and debt. 

–  All  authors  agree  that  enhancement  of  fiscal  discipline  should  be  the  cornerstone  of  any 
Eurobond  project,  independent  on  the  scope  or  guarantee  structure.  Apart  from  the 
'red'/national  issuance,  Favero  and  Missale  suggest  restricting  the  participation  to  the 
Member States with the highest credit rating or to issue only a short-maturity low-risk type 
of  instrument  such  as  T-bills.  Barclays,  BBVA,  Delpla  and  von  Weizsäcker,  Eijffinger, 
Becker  and  Issing  envisage  establishing  independent  fiscal  auditing  bodies  and  special 
euro-area  bodies  that  would  coordinate  fiscal  and  economic  policies.  Under  Delpla's  and 
Weizsäcker's  sophisticated  system,  an  independent  stability  council  would  propose  the 
annual  allocation.  This  allocation  would  subsequently  be  approved  by  the  national 
parliaments  of  participating  Member  States,  having  the  ultimate  budgetary  authority 

EN 

29 

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required to issue the (Blue) Eurobond mutual guarantees. Any country voting against the 
proposed  allocation  would  thereby  decide  to  neither  issue  any  (Blue)  Eurobonds  in  the 
coming  year  nor  guarantee  any  Blue  bonds  of  that  particular  vintage.  Boonstra  proposes 
that countries that break the rules should immediately be severely punished, e.g. by losing 
funds from the EU budget and losing political influence of the voting right in the bodies of 
the ECB. 

–  Practical  aspects  of issuance: Most authors propose establishing a joint debt agency that 
would  coordinate  the  issuance  and  manage  the  debt.  In  the  Blue-Red  bonds  type  of 
proposals  the  issuance  of  the  national  part  of  the  debt  would  remain  with  the  national 
treasuries.  

–  Scope  of  participating  countries:  Becker  enumerates  options  for  the  participation  in  the 
Eurobond.  Those  could  be:  (i) common  bonds  issued  by  countries  with  the  same  rating; 
(ii) joint  bonds  on  an  ad  hoc  basis  similar  to  the  joint  bonds  issued  by  some  German 
federal states; (iii) participation in a common government bond only when EMU countries 
qualify  through  solid  fiscal  consolidation  in  boom  times,  or  (iv) Germany  and  France 
promoting  one  liquid  short-term  instrument  or  a  joint  European  market  for  treasury  bills 
only. 

EN 

30 

   EN 

 
Annex 3: Overview of related existing instruments 

1. 

European Union 

The  European  Commission,  on  behalf  of  the  European  Union,  currently  operates  three 
programmes  under  which  it  may  grant  loans  by  issuing  debt  instruments  in  the  capital 
markets, usually on a back-to-back basis. All facilities provide sovereign lending. The EU is 
empowered  by  the  Treaty  on  the  Functioning  of  the  EU  to  adopt  borrowing  and  guarantee 
programmes that mobilise the financial resources to fulfil its mandate. 

–  Under the BoP programme the EU provides financial assistance to non-euro area Member 
States that are seriously threatened with balance-of-payments (BOP) difficulties (Art. 143 
TFEU). 

–  Under  the  EFSM  programme,  the  European  Commission  is  empowered  to  contract 
borrowings on behalf of the EU for the purpose of funding loans made under the European 
Financial Stability Mechanism (Council Regulation No 407/2010 of 11 May 2010). Since 
December  2010,  support  programmes  for  Ireland  and  Portugal  have  been  agreed  on  for 
EUR 22.5 billion and EUR 26 billion, respectively. 

–  The MFA programme is providing loans to countries outside the European Union. Macro-
Financial  Assistance  (MFA)  is  a  policy-based  financial  instrument  of  untied  and 
undesignated  balance-of-payments  support  to  partner  third  countries  (Art. 212  and  213 
TFEU). It takes the form of medium/long-term loans or grants, or a combination of these, 
and  complements  financing  provided  in  the  context  of  an  International  Monetary  Fund's 
reform programme31. 

Credit Rating 

The  EU’s  AAA  rating  is  a  reflection  of  several  factors.  Borrowings  are  direct  and 
unconditional  obligations  of  the  EU  and  guaranteed  by  all  EU  Member  States.  Budget 
resources are derived almost entirely from revenue paid by Member States independently of 
national  parliaments  including  tariffs  and  duties  on  imports  into  the  EU  and  levies  on  each 
Member State’s VAT receipts and GNI. On this basis, bonds issued by the EU are zero-risk 
weighted and can be used as collateral at the ECB. 

For all borrowings, investors are ultimately exposed to the credit risk of the EU, not to that of 
the beneficiaries of loans funded. Should a beneficiary country default, the payment will be 
made from the EU budget (EUR 127 billion in 2011). EU Member States are legally obliged 
by the EU Treaty to provide funds to meet all EU’s obligations.  

Key Features of EU issuance 

The  EU  has  so  far  issued  benchmark-size  bonds  under  its  Euro  Medium  Term  Note 
programme (EMTN), which has been upsized to EUR 80 billion to take into account issuance 
under the EFSM. The resumption in benchmark issuance started end of 2008, driven by the 
crisis. 

With  the  activation  of  EFSM  for  Ireland  and  Portugal,  the  EU  has  become  a  frequent 
benchmark issuer. The total borrowing plan for the EFSM for 2011 amounts to about EUR 28 
billion  (EUR  13.9  billion  for  Ireland,  EUR  14.1  billion  for  Portugal;  under  BoP  and  MFA: 
about EUR 2 billion). Funding is exclusively denominated in euro. 

As EU assistance is of a medium-term nature, the maturity spectrum is normally 5 to 10 years, 
but can be expanded to a range from 3 to 15 or occasionally 30 years. 

31 

For further information, see 
http://ec.europa.eu/economy_finance/eu_borrower/macro-financial_assistance/index_en.htm  

EN 

31 

   EN 

 
                                                 
 
“Back-to-back”  on-lending  ensures that  the  EU  budget  does  not  assume  any  interest  rate  or 
foreign exchange risk. Notwithstanding the back-to-back methodology, the debt service of the 
bond  is  the  obligation  of  the  European  Union which  will  ensure  that  all  bond  payments  are 
made in a timely manner.  

As  a  frequent  benchmark  borrower,  within  the  above  parameters  the  EU  intends  to  build  a 
liquid  yield  curve.  The  EU  commits  lead  managers  to  provide  an  active  secondary  market, 
quoting two-way prices at all times and it monitors that such commitments are applied. 

Determination of EU funding 

EU  loans  are  financed  exclusively  with  funds  raised  on  the  capital  markets  and  not  by  the 
other Member States nor from the budget. 

The  funds  raised  are  in  principle  lent  back-to-back  to  the  beneficiary  country,  i.e.  with  the 
same  coupon,  maturity  and  amount.  This  back-to-back  principle  imposes  constraints  on  EU 
issuance, i.e. the characteristics of the issued financial instruments are defined by the lending 
transaction, thus implying that it is not possible to fund a maturity or amount different from 
the loan. 

The Council Decision determines the overall amount of the country programme, instalments 
and the maximum average maturity of the loan package. Subsequently, the Commission and 
the  beneficiary  country  have  to  agree  loan/funding  parameters,  instalments  and  tranches 
thereof. In addition, all but the first instalment of the loan depend on compliance with various 
policy conditions similar to those of IMF packages, which is another factor influencing timing 
of funding. This implies that timing and maturities of issuance are dependent on the related 
EU lending activity. 

EFSM Process 

(1) 

(2) 

(3) 

(4) 

(5) 

A Member State which is threatened with a severe economic or financial disturbance 
caused by exceptional occurrences beyond its control may request support from the 
EU under the EFSM. 

The  Council  of  the  EU  decides  by  qualified  majority  voting,  based  on  a 
recommendation by the European Commission. 

The Member State negotiates an economic adjustment programme with the European 
Commission, in liaison with the IMF and the ECB. 

The beneficiary Member State negotiates with the European Commission the details 
of  a  Memorandum  of  Understanding  (MoU)  and  a  loan  agreement  and  decides  on 
implementation. 

Following  signature  of  the  MoU  and  Loan  Agreement,  and  a  request  for 
disbursements  by  the  beneficiary  Member  State,  funds  are  raised  in  international 
capital markets and the first tranche is released. Subsequent tranches of the loan are 
released, once the EU Council has assessed the Member State's compliance with the 
programme conditionality. 

2. 

European Financial Stability Facility (EFSF) 

The European  Financial Stability Facility (EFSF 1.0) was created by the euro area Member 
States (EA MS) following the decision taken on 9 May 2010 by the ECOFIN  Council.  The 
EFSF 1.0 was founded as Luxembourg-registered company. The main purpose of the EFSF is 
to  provide  financial  assistance  to  euro  area  Member  States.  As  part  of  an  overall  assistance 
package of EUR 750 bn, the EFSF received guarantees by euro area Member States totalling 

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EUR 440  billion  for  on-lending  to  euro  area  MS  in  financial  difficulty,  subject  to 
conditionality in the context of an EU/IMF economic adjustment programme. 

Lending capacity 

Under EFSF 1.0 the effective lending capacity of the EFSF is limited to EUR 255 billion in 
order to preserve the AAA rating of EFSF's bonds (see below). 

Credit Rating 

The  EFSF  1.0  has  been  AAA  rated  by  credit  rating  agencies.  However,  under  the  initial 
agreement  (EFSF  1.0),  this  has  come  at  the  expense  of  a  reduced  lending  capacity,  as  each 
EFSF loan has to be covered by i) guarantees  from AAA-rated  sovereigns; ii) an  amount of 
cash  equal  to  the  relevant  portion  of  the  EFSF  cash  reserve;  and  iii) a  loan-specific  cash 
buffer. The AAA rating is essentially based on the following four elements:  

(1) 

(2) 

(3) 

(4) 

Guarantee  mechanism:  The  guarantee  agreement  between  the  euro  area  Member 
States  requires  them  to  issue  an  irrevocable  and  unconditional  guarantee  for  the 
scheduled  payments  of  interest  and  principal  due  on  funding  instruments  issued  by 
the EFSF. Furthermore, the guarantee covers up to 120% of each euro area Member 
State's  share  of  any  EFSF  obligations  (principal  and  interest),  which  is  however 
capped  by  the  respective  Guarantee  Commitments  as  stipulated  in  Annex 1  of  the 
EFSF Framework Agreement. Any shortfall due to this cap would be covered by the 
cash reserves and cash buffer. 

Cash reserve: Funds distributed to a borrower will be net of an up-front service fee, 
which is calculated as 50 bps on the aggregated principal amount of each loan and 
the net present value of the interest rate margin that would accrue on each loan at the 
contractual rate until its scheduled maturity date. 

Loan-specific cash buffer: Each time a loan is provided to a Member State, the EFSF 
has to establish a loan-specific cash buffer, in a size so that each EFSF loan is fully 
covered by AAA guarantees and an amount of cash equal to the relevant portion of 
the EFSF cash reserve plus this respective loan- specific cash buffer. 

Potential additional support: Under the EFSF Framework Agreement, the size of the 
EFSF  Programme  could  be  modified  by  unanimous  approval  by  the  guarantors. 
However,  the  capacity  of  the  EFSF  cannot  be  increased  indefinitely,  as  this  may 
deteriorate  the  credit  position  of  the  guaranteeing  AAA-sovereigns.  Should  any  of 
these loose its AAA rating, the capacity of the EFSF would shrink by the guarantee 
amount provided by that country. 

Bonds issued by the EFSF are zero risk-weighted and ECB repo-eligible. The credit rating of 
the EFSF could be negatively affected by a potential deterioration in the creditworthiness of 
euro  area  Member  States,  especially  the  AAA-rated  guarantors.  As  the  EFSF  is  several 
guaranteed,  a  single  rating  downgrade  of  a  guaranteeing  AAA-sovereign  would  downgrade 
the AAA rating of the EFSF, if no further credit enhancements are put in place. 

Conditionality 

Any  financial  assistance  by  the  EFSF  linked  to  the  existence  of  an  economic  adjustment 
programme  including  strict  policy  conditionality  as  set  out  in  a  Memorandum  of 
Understanding (MoU). The Commission negotiates with the beneficiary country the MoU in 
liaison with the ECB and IMF. 

Decision making 

The decisions to grant funds under the EFSF are taken unanimously. 

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3. 

European Financial Stability Facility (EFSF 2.0) 

The EFSF Framework Agreement has been modified in order to have the full lending capacity 
of EUR 440 billion available.  

Lending capacity 

Under EFSF 2.0 the effective lending capacity of the EFSF is limited to EUR 440 billion in 
order to preserve the AAA rating of EFSF's bonds (see below). 

Credit Rating 

The EFSF 2.0 has received a AAA rating by credit rating agencies. To increase the effective 
EFSF lending capacity to a maximum of EUR 440 billion, a revision of the EFSF Framework 
Agreement  has  been  made  with  a  view  to  having  an  increase  in  the  guarantees  from  AAA-
rated sovereigns to EUR 440 bn. Essentially, then, the AAA rating is based on one element 
only, the guarantee mechanism. 

That  guarantee  agreement  between  the  EA  Member  States  requires  them  to  issue  an 
irrevocable and unconditional guarantee for the scheduled payments of interest and principal 
due  on  funding  instruments  issued  by  the  EFSF.  Furthermore,  the  guarantee  covers  up  to 
165%  of  each  euro  area  Member  State's  share  of  any  EFSF  obligations  (principal  and 
interest), which is however capped by the respective Guarantee Commitments as stipulated in 
Annex 1  of  the  EFSF  Framework  Agreement.  Bonds  issued  by  the  EFSF  are  zero  risk-
weighted and ECB repo-eligible. 

The credit rating of the EFSF could be negatively affected by a potential deterioration in the 
creditworthiness of any euro area Member State, especially of any AAA-rated guarantor. As 
the EFSF is several guaranteed, a single rating downgrade of a guaranteeing AAA-sovereign 
would downgrade the AAA rating of the EFSF, if no further credit enhancements are put in 
place. 

Conditionality 

Any  financial  assistance  by  the  EFSF  is  linked  to  strict  policy  conditionality  as  set  out  in  a 
Memorandum  of  Understanding  (MoU).  The  Commission  negotiates  with  the  beneficiary 
country  the  MoU  in  liaison  with  the  ECB  and  IMF.  Beyond  loans  within  a  macroeconomic 
adjustment  programme,  the  EFSF  can  also  grant  credit  lines,  carry  out  operations  on  the 
primary and secondary bond markets and grant loans outside of programmes for recapitalising 
financial institutions. 

Decision making 

The decisions to grant funds under the EFSF are taken unanimously. 

4. 

European Stability Mechanism (ESM) 

On  24-25  March  2011,  EU  Heads  of  States  and  Governments  endorsed  the  creation  of  the 
ESM as a permanent crisis mechanism to safeguard the euro and financial stability in Europe. 
The  ESM  will  be  world  largest  international  financial  institution,  with  an  EUR  700  billion 
capital, of which EUR 80 billion will be paid in. The entry into force of the ESM was initially 
planned for July 2013, but is expected to be advanced to mid 2012.  

5. 

German Länder joint bonds 

A special segment of the German Länder (states) bond market is the so called Jumbos. These 
are  bonds  issued  by  a  group  of  German  states.  Up  to  now,  38  Jumbos  have  been  issued  by 
syndicates of five to seven states, with the exception of the particularly large Jumbo of 1997 
which was shared by ten states. So far, all Jumbos have been arranged as straight bonds and 

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the average issue size is slightly higher than EUR 1 billion, more than seven times the size of 
an  average  Land  issue.  Participants  of  the  Jumbo  programme  are  mostly  states  which  are 
either small by size or population. Jumbos are more liquid than typical Länder bonds, saving 
the state treasurers part of the liquidity risk premium compared to a rather small single-issuer 
bond. From the investors' point of view, a Jumbo constitutes a structured bond composed of 
separate claims against the participating states according to their share in the joint issue. Thus, 
the states are severally but not jointly liable for the issue. 

Bond characteristics 

–  Issuance frequency: usually 2-3 issues per year 

–  Maturities: 5-10 years 

–  Size: EUR 1-1.5bn  

–  One state coordinates the issue and acts as a paying agent.  

Credit Rating 

The  issues  are  rated  AAA  by  Fitch.  Background  is  that  Fitch  until  recently  assigned  AAA 
ratings  to  all  German  states  because  of  the  Länderfinanzausgleich  (this  is  an  equalisation 
process  which  is  a  solidarity  and  implicit  guarantee  mechanism  between  the  Länder  and 
ultimately the federal state). This also explains the often split ratings between Fitch and the 
other agencies. Note that not all German Länder are rated by Fitch any more. 

According  to  Fitch,  the  AAA  rating  reflects  the  individual  creditworthiness  of  all  seven 
German  federated  states  involved  in  the  joint  issuance.  It  is  based  on  the  strong  support 
mechanisms that apply to all members of the German Federation and the extensive liquidity 
facilities they benefit from, which ensure timely payment and equate the creditworthiness of 
the states to that of the Federal Republic of Germany. Fitch notes that the support mechanisms 
apply uniformly to all members of the German Federation: the federal government (Bund) and 
the  16  federated  states.  The  differences  in  the  federated  states'  economic  and  financial 
performances  are  irrelevant,  as  all  Länder  are  equally  entitled  to  financial  support  from  the 
federal  government  in  the  event  of  financial  distress.  German  Länder  joint  bonds  are  zero-
risk-weighted and ECB repo-eligible. 

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Annex 4: Documentation and market conventions 

As  mentioned  in  Section 4,  the  introduction  of  a  Stability  Bond  would  require  determining 
various security characteristics and market conventions would need to be determined. These 
would possibly include:  

–  Jurisdiction  of  Stability  Bond  issuance:  EFSF  and  EU/EFSM  bonds  are  issued  under 

English law, but this may be meet political resistance in this case. 

–  Maturity  structure  of  securities:  The  funding  strategy  of  the  Stability  Bond  should  be 
determined  with  a  view  to  i)  develop  a  benchmark  issues  and  a  yield  curve,  and  ii)  to 
optimise funding costs, as issuing in some segments of the yield curve is more costly than 
for others. The issuance of short-term paper (t-bills) in addition to longer maturities would 
improve the flexibility of the treasury and would improve access to funding significantly. 

–  Coupon  types  (fixed,  variable,  zero,  inflation-linked):  For  a  start  and  to  facilitate  the 
development  of  benchmark  status,  it  may  be  preferable  to  concentrate  on  plain  vanilla 
security  structures.  This  would  also  facilitate  the  development  of  related  derivative 
instruments, in particular options and futures. 

–  Stock  exchange  on  which  securities  would  be  listed:  EFSF  and  EU/EFSM  bonds  are 
currently listed on the Luxembourg exchange. For the Stability Bond this may prove to be 
too limited although listing on several exchanges would involve additional costs. 

–  Settlement  conventions:  These  conventions  should  be  set  with  a  view  to  support  the 
attractiveness of  the  instruments,  i.e. for short-term paper with t+1 (to  facility short-term 
treasury  objectives)  and  for  longer-term  securities  with  t+3  (to  minimize  the  risk  of 
settlement failures). 

–  Strategy  to  create  and  maintain  an  investor  basis:  Relationships  with  potential  investors 
would need to be established and could require decisions on whether a group of primary 
dealers will need to be established, how the retail sector will be integrated, etc.  

–  Introduction of Collective Action Clauses, to allow for an organised procedure to resolve 

any future solvency issues.  

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