COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT An enabling regulatory framework for the development of sovereign bond-backed securities (SBBS) Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on sovereign bond-backed securities
Date: 2018-06-29
Institutions: Directorate-General for Financial Stability, Financial Services and Capital Markets Union, European Commission
Subjects: European Securities and Markets Authority, bond, euro area, financial legislation, financial risk, financial stability, financial supervision, public borrowing

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 29.6.2018  SWD(2018) 252 final/2  CORRIGENDUM This document corrects SWD(2018) 252 final of 24.5.2018. This version corrects a mistake in Figure 3 on page 9, specifically: the ECB original capital key for France should have read 0.142 rather than 0.242. The other values in the table which depend via algebraic manipulation on this entry are also suitably corrected. The text should read as follows: COMMISSION STAFF WORKING DOCUMENT  IMPACT ASSESSMENT  An enabling regulatory framework for the development of sovereign bond-backed securities (SBBS) Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on sovereign bond-backed securities {COM(2018) 339 final}  - {SEC(2018) 251 final}  - {SWD(2018) 253 final}  
 
 
Table of contents 

1. 

2. 

INTRODUCTION: POLITICAL AND LEGAL CONTEXT ............................................................... 4 

PROBLEM DEFINITION .................................................................................................................... 9 

2.1.  What is the problem? ......................................................................................... 9 
2.2.  What are the problem drivers? ........................................................................ 12 
2.3.  How will the problem evolve? ........................................................................ 15 

3.  WHY SHOULD THE EU ACT? ........................................................................................................ 16 

3.1.  Legal basis ....................................................................................................... 16 
3.2.  Subsidiarity (Necessity of EU action) ............................................................. 17 
3.3.  Subsidiarity (Value added of EU action) ......................................................... 17 

4.  OBJECTIVES: WHAT IS TO BE ACHIEVED? ............................................................................... 17 

4.1.  General objectives ........................................................................................... 17 
4.2.  Specific objectives ........................................................................................... 18 

5.  WHAT ARE THE AVAILABLE POLICY OPTIONS? .................................................................... 19 

5.1.  What is the baseline from which options are assessed? .................................. 19 
5.2.  Description of the policy options .................................................................... 22 
5.3.  Options discarded at an early stage ................................................................. 23 

6.  WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? ........................................................... 24 

6.1.  Scenarios and benchmarks of benefits and costs ............................................. 24 
Scenarios ............................................................................................................... 24 
6.1.1. 

6.1.2. 

Benchmarks of benefits and costs ......................................................................... 24 

6.2.  Scope of applicability of the proposed legislation .......................................... 25 
Option 1.1: only SBBS proper .............................................................................. 25 
6.2.1. 

6.2.2. 

Option 1.2: All securitisations of euro area sovereign bonds ................................ 27 

Option 1.3: A basket of euro-are sovereign bonds (with weights according to the 

6.2.3. 
official "SBBS recipe") ......................................................................................................... 28 

6.2.4. 

Impact summary and conclusions ......................................................................... 30 

6.3.  Extent of ’restored’ regulatory neutrality ........................................................ 31 
6.3.1. 
tranches  32 

Option 2.1: Extend the regulatory treatment of euro area sovereign bonds to all 

Option 2.2: Extend the regulatory treatment of euro area sovereign bonds only to 

6.3.2. 
senior tranches ....................................................................................................................... 33 

6.3.3. 

Impact summary and conclusions ......................................................................... 34 

6.4.  Ensuring  compliance  with  SBBS  criteria  and  consistency 

in 

implementation ................................................................................................ 34 
Option 3.1: A compliance mechanism based on self-attestation ........................... 35 

6.4.1. 

6.4.2. 

Option 3.2: Option 3.1, with the involvement of third-parties .............................. 37 

1 

 
 
6.4.3. 

Option 3.3: Option 3.1 with ex-ante supervisory checks on each issuance ........... 38 

6.4.4. 

Impact summary and conclusion ........................................................................... 39 

7.  HOW DO THE OPTIONS COMPARE? ............................................................................................ 40 

8. 

PREFERRED OPTION ...................................................................................................................... 43 

8.1.  Preferred model ............................................................................................... 43 
8.2.  REFIT (simplification and improved efficiency) ............................................ 43 

9.  HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED? .................................. 43 

LIST OF REFERENCES .............................................................................................................................. 45 

ANNEX 1  PROCEDURAL INFORMATION ......................................................................................... 47 

1. 

LEAD DG, DECIDE PLANNING/CWP REFERENCES .................................................................. 47 

2.  ORGANISATION AND TIMING ...................................................................................................... 47 

3. 

4. 

CONSULTATION OF THE RSB ....................................................................................................... 47 

EVIDENCE, SOURCES AND QUALITY ......................................................................................... 47 

ANNEX 2  STAKEHOLDER CONSULTATION .................................................................................... 48 

1. 

RESULTS  FROM  THE  ESRB  PUBLIC  SURVEY  ON  SOVEREIGN  BOND-BACKED 
SECURITIES ...................................................................................................................................... 48 

1.1  Senior SBBS .................................................................................................... 48 
1.2 
Junior SBBS .................................................................................................... 52 
1.3  Regulation ........................................................................................................ 56 
1.4  Economics of SBBS issuance .......................................................................... 58 

2. 

SUMMARY OF THE INDUSTRY WORKSHOP ............................................................................. 62 

Session 1: Motivation ................................................................................................ 63 
Session 2: Sovereign debt markets ............................................................................ 64 
Session 3: Commercial banks .................................................................................... 65 
Session 4: Non-bank Investors .................................................................................. 66 
Session 5: Demand for junior SBBS ......................................................................... 67 
Session 6: Risk measurement .................................................................................... 67 

3.  MAIN TAKEAWAYS OF THE CLOSED-DOOR DMO WORKSHOP........................................... 68 

ANNEX 3  WHO IS AFFECTED AND HOW? ........................................................................................ 69 

1. 

2. 

PRACTICAL IMPLICATIONS OF THE INITIATIVE .................................................................... 69 

SUMMARY OF COSTS AND BENEFITS ....................................................................................... 73 

ANNEX 4  ANALYTICAL METHODS ................................................................................................... 79 

1. 

2. 

3. 

4. 

5. 

EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT PRESENT ............... 79 

EVIDENCE  ON  THE  EXTENT  OF  "HINDRANCE"  FACED  BY  SBBS  AT  POST 
1/1/2019 .............................................................................................................................................. 81 

PRESENTATION OF THE ANALYSIS BY THE ESRB LIQUIDITY WORKING GROUP 
ON  THE  EFFECTS  OF  SBBS  ON  NATIONAL  SOVEREIGN  BOND  MARKET 
LIQUIDITY ........................................................................................................................................ 82 

IMPACT ON THE VOLUME OF AAA ASSETS ............................................................................. 97 

IMPACT ON THE COMPOSITION OF BANKS' SOVEREIGN PORTFOLIOS ............................ 98 

2 

 
Term or acronym 

Meaning or definition 

AIFMD 

Alternative Investment Fund Managers 

Glossary 

BRRD 

CCP 

CET1 

CIU 

CRD 

CRR 

CSD 

DMO 

EBA 

ECB 

EIOPA 

EMU 

ESM 

ESRB 

EU 

HLTF 

HQLA 

IORP 

Bank Recovery and Resolution Directive (Directive 2014/59/EU)  

Central Counter Parties 

Core Tier-1 Capital 

Collective Investment Unit/Undertaking 

Capital Requirement Directive IV (Directive 2013/36/EU) 

Capital Requirement Regulation (Regulation (EU) 575/2013) 

Central Securities Depositories 

Debt Management Office 

European Banking Authority 

European Central Bank 

European Insurance and Occupational Pensions Authority 

Economic and Monetary Union 

European Stability Mechanism 

European Systemic Risk Board 

European Union 

High Level Task Force 

High-Quality Liquid Assets 

Institutions for Occupational Retirement Provision 

IRB bank 

A bank using "Internal Ratings-Based" models to calculate its capital requirements  

LCH 

LCR 

NSFR 

RTSE 

SA bank 

SBBS 

SCR 

SPV 

SSM 

London Clearing House 

Liquidity Coverage Ratio 

Net Stable Funding Ratio 

Regulatory Treatment of Sovereign Exposures 

A bank using the "Standardised Approach" to calculate its capital requirements 

Sovereign Bond-Backed Securities 

Solvency Capital Requirement 

Special purpose vehicle 

Single Supervisory Mechanism 

STS securitisation 

Simple, transparent and standardised securitisation 

TFEU 

UCITS 

Treaty on the Functioning of the European Union 

Undertakings for Collective Investment in Transferable Securities 

3 

 
 
1. 

INTRODUCTION: POLITICAL AND LEGAL CONTEXT 

A novel concept—that of Sovereign Bond-Backed Securities, or SBBS (see Box 11)—
has  attracted  the  attention  of  academics  and  policy  makers  alike  as  a  possible  tool  to 
address  the  "home  bias"  in  banks'  sovereign  portfolios  (see  Box 2)  and  further  weaken 
the banks-sovereign nexus  (see  Box 3),  two vulnerabilities that  were at the heart of the 
last financial and economic crisis.  

SBBS are appealing because, by design, they would not suffer from some of the pitfalls 
associated with other widely discussed reforms to address these key vulnerabilities, e.g. 
the  introduction  of  Eurobonds2  and  a  reform  of  the  regulatory  treatment  of  sovereign 
exposure  (RTSE)  to  discourage  concentrated  investment  in  sovereign  bonds,  especially 
of the riskier ones. Specifically:  

1.  Differently  from  Eurobonds,  SBBS  would  not  involve  mutualisation  of  risks  and 
losses  among  Member  States.  Risk/loss  mutualisation  is  seen  as  problematic  by 
many because it might encourage moral hazard.  

2.  SBBS  do  not  present  the  same  risks  for  financial  stability  as  would  stem  from  an 
untimely  RTSE reform.  It is  precisely to ward off such  financial stability risks  that 
the  Commission's  stance  on  RTSE,  as  reiterated  e.g.  in  the  May  2017  Reflection 
Paper3  on  deepening  the  economic  and  monetary  union  (EMU),  is  that  it  can  only 
happen once Banking Union, Capital Markets Union, and a European safe asset are 
in place (section 2.3). 

SBBSs are tranches issued against a diversified portfolio of euro-area central government 
bonds.  The  diversification  of  the  underlying  portfolio  and  the  conservative  tranching 
threshold (i.e., a sufficiently large loss-absorbing sub-senior tranche) would ensure a very 
high  level  of  safety  for  the  senior  tranche.  The  tranching  would  in  effect  concentrate 
sovereign risk into the junior and, to a lesser extent, mezzanine tranches. If the latter two 
tranches are bought by investors whose losses are less likely (than, say, those of banks) 
to create spillovers to the public purse, the risk of feedback loops in case of stress in one 
or more euro area sovereigns would be further reduced.4 5 

An inter-institutional High Level Task Force (HLTF) was established in mid-2016 under 
the  aegis  of  the  ESRB  and  the  Chairmanship  of  Central  Bank  of  Ireland  Governor 
Philip Lane  to  assess  the  feasibility,  merits  and  risks  of  SBBSs.  The  European 
Commission  (henceforth,  the  Commission)  has  actively  contributed  to  the  work  of  this 
task  force,  which  also  comprised  representatives  from  16  national  central  banks,  the 
ECB, the EBA, the EIOPA, as well as of Member States' Debt Management Offices and 
academics (for the list of HLTF members, see Annex 1 of the HLTF report).  

1 See also Brunnermeier et al. (2016b). 
2 A classical Eurobond is a bond guaranteed jointly and severally by all participating Member States. 
3 https://ec.europa.eu/commission/publications/reflection-paper-deepening-economic-and-monetary-union_en 
4 An alternative way to pool sovereign bonds would be in a basket with a specific composition, which would be 

equivalent to a securitisation with a single junior tranche (see section 6.2.3). 

5 Of course, SBBS would per se not achieve the optimal overall diversification of banks' balance sheets. They 
can help diversify banks' sovereign exposures. To the extent that banks also diversify geographically their 
other assets (i.e., through cross-border lending to non-financial corporates and households) the sovereign-
bank nexus would be further weakened. 

4 

 
                                                      
Based on the work conducted by the HLTF and its own analysis, in the above mentioned 
May 2017 Reflection paper on deepening EMU, the Commission has put forward SBBS 
as a possible tool that could be launched in the short term6 to enhance diversification of 
banks' sovereign exposures. 

In  the  Letter  of  Intent  accompanying  his  2017  State  of  the  Union  Address, 
President Juncker  has  committed  the  Commission  to  propose  by  2018  an  "enabling 
framework  for  the  development  of  SBBS  to  support  further  portfolio  diversification  in 
the banking sector."  

Finally, in its October 2017 Banking Union Communication, the Commission reiterated 
its  view  that  SBBS  "have  the  potential  to  contribute  to  the  completion  of  the  Banking 
Union  and  the  enhancement  of  the  Capital  Markets  Union"  by  "support(ing)  further 
portfolio  diversification  in  the  banking  sector,  while  creating  a  new  source  of 
high-quality collateral particularly suited for use in cross-border financial transactions". 
On  this  basis,  the  Communication  notes  that  "building  on  the  outcome  of  the  [ESRB 
HLTF]  work  in  December  2017  and  consultations  with  relevant  stakeholders,  the 
Commission  will  consider  putting  forward  a  legislative  proposal  for  an  enabling 
framework for the development of sovereign bond-backed securities in early 2018." 

The  HLTF  has  concluded7  that,  while  they  would  not  address  fully  all  the  known 
structural  vulnerabilities  of  the  euro  area  financial  sector,  SBBSs  do  have  potential  to 
improve  on  the  status  quo.  However,  SBBS  are  unlikely  to  emerge  under  the  current 
regulatory  framework,  since  the  latter  would  impose  on  them  additional  charges  and 
discounts  (relative  to  those  faced  by  the  sovereign  bonds  in  the  underlying  portfolio), 
making SBBS uneconomical to produce and unattractive to hold (see section 2.1).  

The HLTF found that a gradual development of a demand-led market for SBBS may be 
feasible  under  certain  conditions.8  A  key  necessary  condition,  however,  is  for 
an SBBS-specific  enabling  legislation  to  provide  the  conditions  for  a  sufficiently  large 
investor base, including both banks and non-banks.  

This  impact  assessment  studies,  therefore,  whether  and  how  to  adapt  the  current 
regulatory  framework  to  better  take  into  account  the  features  and  properties  of  these 
novel instruments. Doing so would make it possible for SBBS to undergo a true "market 
test",  which  is  the  only  way  to  ascertain  whether  they  are  economically  feasible  or  not 
once relieved of the existing regulatory hindrances. 

6 Other measures, such as a European safe asset, would require more analysis and more time (again, see EMU 

reflection paper). 

7 The final report is available at https://www.esrb.europa.eu/pub/task_force_safe_assets/html/index.en.html.  
8 Many market participants have argued strongly that the viability of SBBSs would be greatly enhanced if the 

junior tranches were supported by some form of public guarantee (for example replies to the public survey, 
Annex 2, section 1 and DMO's views, annex Annex 2, section 3). As discussed below (see section 5.3), there 
is no appetite to offer such guarantees. Indeed the key feature of SBBS, which has gained them support 
among a cross-section of policymakers, is precisely that they would not involve any public support, and that 
they would rather rely exclusively on mutualisation of risks among private investors. 

5 

 
                                                      
Box 1: The concept of SBBS 

SBBS consist of different claims (tranches) of ranked seniority on an underlying diversified portfolio 
of  (euro  area)  sovereign  bonds  put  together  by  a  Special  Purpose  Vehicle  (SPV)  (see  Figure 1). 
Depending  on  how  the  market  would  develop,  one  or  several  arrangers  would  issue  the 
instrument. The weights of the various sovereign bonds in the underlying portfolio would be fixed (e.g., in 
line  with  each  country's  GDP,  or  the  ECB  key),  as  would  their  tranching  structure  (i.e.,  number  of 
tranches—e.g.,  a  senior,  a  mezzanine  and  a  junior  tranche—and  tranching  points).  The  portfolio  would 
initially cover central government bonds of euro 
area  countries.  The  scheme  could  start  off  at  a 
relatively small scale, and would be envisaged to 
cover up to a fraction of Member States' bonds, 
so as to leave a balance of national bonds in the 
market,  for  market  discipline  purposes.  As 
mentioned,  SBBS  would  be  different  from 
classical  Eurobonds  in  that  they  would  not  rely 
on  any  risk  sharing  or  fiscal  mutualisation 
between Member States.  

Figure 1: Balance sheet of a special-purpose 
vehicle issuing SBBS with three tranches 

By virtue of this tranching with seniority, the 
junior  tranche  would  be  first  in  line  to  take 
any losses that might arise in the tail event of 
a  sovereign  default.  With  an  appropriate 
tranching  point,  the  intention  is  that  the 
senior tranche would constitute "safe" or low-risk assets.9  

SBBS, and in particular the senior tranche, could potentially yield tangible benefits for the overall 
financial architecture in Europe. In particular, they would help: 

  Allow banks and other investors to diversify their sovereign  bond portfolios—whose home 
bias  is  presently  a  key  conduit  of  the  sovereign-bank  nexus—at  relatively  low  transaction 
costs. This would thus help avoid the financial fragmentation observed over the course of the 
sovereign  debt  crisis,  when  yield  differences  between  euro  area  Member  States  widened. 
With SBBS, safe haven flows would move also across instruments (i.e. from the junior to the 
senior  tranche)  rather  than  just  across  borders  (i.e.,  from  sovereigns  with  weaker  fiscal 
positions to those with stronger ones. 

  Alleviate  safe  asset  scarcity  in  Europe:  Expand  the  supply  of  (euro-denominated)  "safe" 
(high-rated) assets, which has been falling due to the many downgrades experienced in the 
wake  of  the  crisis,  against  the  regulation-induced  increased  demand  for  high-quality  liquid 
assets,  especially  in  the  context  of  the  Liquidity  Coverage  Ratio  (LCR).  Importantly,  all 
qualifying  euro  area  Member  States  would  indirectly  contribute  to  such  a  high-rated  asset. 
So the gains from the "exorbitant privilege" of producing safe assets would be more evenly 
shared than is the case now. 

  Create a risk-free rate benchmark curve against which other securities could be priced.  
  Create  an  asset  that  the  ECB  could  use,  if  they  so  choose,  to  conduct  monetary  policy 

operations without risking been perceived as supporting a particular Member State.  

Basing the SBBS' underlying portfolio on the ECB key has several objectives:  

  First,  it  is  meant  to  ensure  that  the  benefits  (and  any  costs)  associated  with  the  expanded 
supply of low risk assets accrue in a balanced manner to all euro area Member States. This is 
an  important  consideration,  not  just  in  point  of  fairness,  but  also  in  terms  of  efficiency. 
Specifically,  if  SBBS  manage  to  become  a  ’benchmark’-like  security,  they  (in  particular 
their senior tranche) may be used by investors as a low-risk alternative to build or to unwind 

9 Of course, no asset can be made to be fully safe. The analysis by the HLTF shows that a 70-percent thick senior 

tranche would have a five-year expected loss rate of 0.5% or less ("at least as safe as German Bunds"). 

6 

Assets LiabilitiesJunior trancheEuro area (central) government bonds            (e.g., ECB capital key weights)Senior TrancheMezzanine trance 
                                                      
 
positions  in  euros.  This  means,  for  example,  that  if  there  is  an  increase  in  the  demand  for 
’low risk’ euro exposures, investors could purchase the (senior) SBBS rather than the bonds 
of the (select) high rated euro-area Member States. As a result, any downward pressure on 
interest rates would be spread throughout the euro area, and not skewed to benefit only a few 
Member States and the borrowers in these jurisdictions. This is positive for Member States 
that would otherwise not benefit from this enhanced demand for euro exposure, and also for 
high-rated  Member  States,  which  otherwise  could  experience  unduly  low  interest  rates, 
potentially  leading  in  turn  to  overheating,  misallocation  of  investment,  as  well  as  to 
challenges for some investor classes (e.g., pension funds). 

  Second,  it  is  meant  to  facilitate  standardisation  of  SBBS  over  time,  as  the  ECB  key  is 
relatively stable (especially if applied on multi-year averages of the underlying determinants, 
e.g. population and GDP levels). 

  Finally, it is meant to avoid potential moral hazard associated with other likely candidates for 
standardised  portfolio  composition,  and  in  particular  with  the  relative  share  of  outstanding 
individual  governments'  debt  on  the  total  (as  countries  with  larger  debt  stocks  would  then 
benefit disproportionately). 

Box 2: The bank-sovereign nexus 

Sovereign  and  banking  stress  can  reinforce  each  other  through  a  number  of  channels, 
especially in times of economic stress.  A worsening of the financial situation of the sovereign 
leads to deterioration in the market value of government debt, including that held by the banks, 
reducing their loss absorption capacity (at market prices) and hindering their ability to lend to the 
economy.10 In turn, this further depresses economic activity, lowering tax revenue and adding to 
the funding pressure on the sovereign. In the past, the state was furthermore perceived to provide 
the  ultimate  backstop  to  ensure  banking  stability,  either  by  injecting  capital  or  by  providing 
liquidity. Therefore, banking stress increased the contingent liabilities for the government, raising 
its financing costs. This further exacerbated the feedback loop.11 

Figure 2: The bank-sovereign nexus 

Source: Brunnermeier et al. (2016b) 

The sovereign-bank nexus was one of the main factors amplifying  financial distress in the 
euro area during the last financial and economic crisis. High stock of public debt in Greece 
and Italy combined with increased exposure of these countries' banking sectors (and, in the case 
of Greece, of Cypriot banks also) to sovereign finances. Meanwhile, imprudent lending practices 
by  Irish,  Spanish  and  Slovenian  banks  built  up  high  and  in  some  cases  excessive  risk  on  bank 

10 This channel is exacerbated in countries with high levels of government debt or where there is prevalent home 

bias in banks' sovereign portfolios (Box 3). 

11 For a more detailed discussion, also Banca d'Italia (2014). 

7 

 
 
 
                                                      
balance sheets, and subsequent public intervention put significant strain on the finances of their 
respective  sovereigns.12  The  concomitant  hikes  in  funding  costs  put  significant  strain  on 
economic activity in these countries. 

Thus,  addressing  this  feedback  loop  enhances  financial  stability  and  increases  resilience. 
Mitigating the link between sovereign and financial stress through prudent policy making, greater 
asset diversification and building up credible backstops, would reduce the overall level of risk in 
the  economy.  In  turn,  this  would  limit  the  cost  of  sunspot-driven  crises,  thereby  enhancing 
financial stability. 

Several important steps have been taken in recent years towards a full Banking Union, thus 
weakening  the  bank-sovereign  nexus.  For  example,  (major)  euro-area  banks  are  now 
supervised  at  the  EU  level  (by  the  SSM)  and  (if  necessary)  resolved  by  the  Single  Resolution 
Mechanism  supported  by  the  Single  Resolution  Fund.  Furthermore,  a  backstop  for  the  Single 
Resolution  Fund  is  being  established,  which  means  that  banks  can  be  resolved  efficiently  and 
effectively,  irrespective  where  they  are  headquartered.  Furthermore,  the  Commission  has 
proposed the establishment of a backstop to the Single Resolution  Fund, to be provided by the 
ESM, or the (future) European Monetary Fund.13 

Box 3: The home bias in banks' sovereign portfolios 

A key factor that strengthens the link from a sovereign to its banks is the so-called "home 
bias" in banks' sovereign bond portfolios, i.e. banks are typically most exposed to their own 
sovereign. This home bias actually increased in the wake of the euro area debt crisis, in particular 
in  more  vulnerable  Member  States,  even  if  more  recently,  also  supported  by  government  bond 
purchases by the ECB, banks have somewhat reduced their holdings of government bonds.  

The table in Figure 3 reports the size of banks' holdings of bonds of their own sovereign in EU 
Member  States,  both  in  nominal  value  as  a  share  of  banks'  overall  sovereign  bond  portfolios. 
When this share is disproportionately large (for example, compared to the Member State's share 
in the ECB capital key), it gives rise to so-called "home bias". 

As shown in Figure 3, the degree of "home bias" is not homogenous within the euro area, with 
the share of exposure to the home sovereign relative to the total of sovereign exposures ranging 
from 8.3% (Luxembourg) to 61.3% (Slovenia) in the sample. This share is generally well above 
each Member States' share in the ECB capital key, except for French banks.14  

Several  factors  can  explain  why  a  bank  would  prefer  holding  bonds  issued  by  its  home 
sovereign. The first one is simply the better knowledge of the home sovereign's creditworthiness 
(see Persaud (2017)), compared to that of more remote sovereigns. Another one refers to possible 
differences  in  perceived  default  probabilities:  investors  (and  banks  in  particular)  might  believe 
that  a  sovereign  in  financial  difficulty  may  try  to  prioritise  servicing  its  domestic  debt  (and  in 
particular,  domestic  banks)  over  bonds  held  by  foreign  investors  (see  Guembel  and  Sussman 
(2009)).  In  addition,  banks  may  also  accumulate  domestic  sovereign  exposure  if  they  consider 
that the additional risk of holding such debt is negligible: if the home sovereign  was to fail, the 
bank  is  likely  to  fail  anyway,  since  its  exposures  to  the  domestic  economy  are  likely to  sour.15 
Finally,  domestic  banks  may  be  subject  to  "moral  suasion".  In  particular,  government-owned 

12 See Erce. A (2015) for a discussion of the factors which affect the extent of spillovers from banks to the 

sovereigns, such as the size of the banks' balance sheets, the structure of their liabilities, and the level of non-
performing loans. 

13 https://ec.europa.eu/commission/publications/completing-europes-economic-and-monetary-union-

factsheets_en 

14 Recent data show a reduction in euro area banks' holdings of government debt by 17% between 2015 and 

2017, which thus also reduces their financial connection with their sovereign. 

15 As Horváth, B L, H Huizinga, and V Ioannidou (2015) put it: "additional domestic sovereign exposure cannot 

hurt them (banks) much, because they are likely to fail anyway if their sovereign defaults". 

8 

 
 
                                                      
banks and banks under political influence (through  government  seats  at the  Board of directors) 
report higher home bias in sovereign debt, and such moral suasion is stronger in countries under 
stress (see De Marco and Macchiavelli (2016)). 

Figure 3: Banks' exposure to domestic sovereign bonds as of 30 June 2016 

Source: EBA 2016 Transparency Exercise; ECB (for capital key) 
Notes: 1/ Rebased to 100 using only listed Member States; 2/ difference between figures in third and fifth columns. 

Some commentators have associated banks' home bias in sovereign exposure with the regulatory 
treatment of sovereign exposures, since sovereign debt denominated in the domestic currency is 
considered  risk-free,  providing  banks  with  strong  incentives  for  holding  such  bonds.  However, 
this doesn't explain the prevalence of the home bias in the euro area, since all sovereign bonds 
from euro area countries are treated in the same way for euro area banks. 

2.  PROBLEM DEFINITION 

2.1.  What is the problem? 

The  problem  that  the  proposed  initiative  would  address  is  that  the  current  regulatory 
framework impedes the development by the private sector of SBBS. 

This  is  because,  under  the  current  regulatory  framework,  SBBSs  would  be  treated  as 
securitisation  products,  and  hence  significantly 
less  favourably—along  several 
dimensions—than  their  underlying  portfolio  of  euro  area  sovereign  bonds  (see  Box 4). 
For example, banks would face lower capital requirements (indeed, zero) by holding the 
underlying  sovereign  bonds  rather  than  SBBS  tranches.  Moreover,  whereas  banks 
currently extensively use euro area sovereign bonds for the purposes of meeting liquidity 
coverage  requirements  (LCR  and  NSFR),  as  well  as  collateral  (including  to  access 
liquidity from the ECB), SBBS tranches would not be eligible for these key purposes. 

Thus, unless the regulatory framework is suitably adapted, investors would always rather 
prefer to invest directly in the underlying government bonds than in SBBS.  

9 

OriginalRebased 1/Austria 58,96811,66619.8%2.0%2.8%16.9%Belgium118,37026,68322.5%2.5%3.6%19.0%Cyprus2,42890737.4%0.2%0.2%37.2%Finland7,9361,10313.9%1.3%1.8%12.1%France466,817136,98029.3%14.2%20.5%8.8%Germany331,943118,09135.6%18.0%26.1%9.5%Greece55,55212,33322.2%2.0%2.9%19.3%Ireland30,48715,30150.2%1.2%1.7%48.5%Italy364,109152,69041.9%12.3%17.8%24.1%Latvia1,56526216.7%0.3%0.4%16.3%Luxembourg7,9616578.3%0.2%0.3%8.0%Malta1,84586947.1%0.1%0.1%47.0%Nederlands161,12441,19925.6%4.0%5.8%19.8%Portugal43,33323,03953.2%1.7%2.5%50.6%Slovenia3,3352,04561.3%0.3%0.5%60.8%Spain374,27586,45123.1%8.8%12.8%10.3%Total2,030,047630,27431%69.0%100.0% n.a.ECB key"home bias" proxy 2/Sovereign bonds (million EUR)Home sovereign bonds (million EUR)Home sovereign bonds / total sovereign bonds 
 
This  has  been  confirmed  by  the  many  interactions  with  market  participants  (both 
candidate  producers  and  candidate  buyers  of  SBBS)  in  consultations  conducted  in  the 
context of the HLTF work on SBBS. It is for this reason that the HLTF report concludes 
that,  "ultimately,  the  level  of  investor  demand  for  SBBS  and  its  impact  on  financial 
markets is an empirical question, which can only be tested if an enabling regulation for 
the securities is adopted". 

Box 4: SBBS versus government bonds in the existing regulatory framework 

Under  the  current  regulatory  framework,  SBBS  would  be  treated  as  securitised  products  because 
they entail tranching and subordination of credit risk. In regulation, these two elements define a securitised 
product, regardless of the underlying composition of the portfolio or its risk.16  

As a direct consequence of this fact, SBBS would receive an unfavourable treatment compared with 
that of the underlying sovereign bonds along several dimensions, as described below.  

Capital requirements  

For financial institutions (banks), holding a securitised product rather than the underlying portfolio 
gives  rise  to  higher  capital  requirements.  The  justification  for  such  non-neutrality  in  the  treatment  of 
securitisations relative to that of the underlying portfolio comes from model risk (i.e. a higher sensitivity of 
the  securitisation  price  to  errors  in  estimating  probabilities  of  default,  losses  given  default,  and  default 
correlation  of  the  underlying  assets).  Non-neutrality  is  also  justified  by  agency  risk,  since  securitisation 
involves a greater number of parties with potentially conflicting interests (e.g. servicing, counterparty, and 
legal risk) than does holding the underlying assets.17  

In  particular,  as  per  the  Capital  Requirements  Regulation  (CRR,  Regulation  (EU)  No 
575/2013, Articles 242-270), generally18 there is a floor for the risk weight on securitisation 
positions of 7% for banks using the Internal Ratings Based approach (IRB banks) and 20% for 
banks using the Standardised Approach (SA banks).  

As  regards  instruments  held  in  the  trading  book,  SBBS  would  face  significant  higher 
charges for interest rate risk. Sovereign bonds in the trading book are subject to a small capital 
charge for interest rate risk. By contrast, securitised products need to be supported by capital of 
8% of the amount calculated under the banking book.19 Risk weights to account for general risks 
would be, instead, similar for SBBS and sovereign bonds, if the two instruments have the same 
duration  and  market  value.  In  particular,  the  treatment  of  specific  risk  in  the  Standardised 
Approach is similar to the one for credit risk, in practice leading to a zero risk weight for specific 
risk.20  

SBBS  would  not  qualify  as  a  simple,  transparent  and  standardised  securitisation  (STS) 
under  the  recently  approved  STS  legislation  (Regulation  (EU)  2017/2402).  The  latter  explicitly 
excludes securitisations of “transferable securities” (such as sovereign bonds) from the products 

16 Article 4(61) of the CRR. 
17 A third factor in typical securitisation is that the underlying securitised loans are not exposed to market risk 

(since they are not tradeable), in contrast with the securitised product. 

18 In some cases (see for instance Articles 252 and 260 of the CRR) caps may be allowed that could result in 

lower risk weights for SBBS tranches than the floors mentioned here. Similarly, Regulation (EU) 2017/2401, 
which comes into force on 1/1/2019, will allow IRB banks that are capable of assessing the risk 
characteristics of each individual asset in the underlying pool to apply a maximal capital requirement for 
securitisation positions equal to the capital requirements if the underlying exposures had not been securitised. 
Depending on the risk weights of the underlying exposures, this could imply a lower risk weight than the 
floor, including for non-senior bonds. It needs to be kept in mind that many IRB banks have a risk weight 
higher than 0% on their sovereign exposures. Thus, even if the cap is applied, the risk weights for senior 
SBBS would not necessarily be 0%.  

19 Article 337 of the CRR. 
20 Article 336 of the CRR, Table 1 translates a 0% risk weight in the banking book to a 0% risk weight in the 

trading book. 

10 

 
 
                                                      
that  may  qualify  as  STSs,  since  it  aims  at  spurring  banks  to  originate  new  loans  (especially  to 
SMEs) in support of the real economy, as opposed to repackaging the debt of financial entities or 
government  bonds. Moreover, for a securitisation to qualify as STS, no single underlying asset 
can exceed 1% of the total portfolio. In the case of SBBS constructed in line with the ECB capital 
key, this limit would be exceeded by the sovereign bonds of 11 Member States. 

For insurance companies, Solvency II provides two ways of calculating the Solvency Capital 
Requirement (SCR): an internal model (either full or partial) or the standard formula. The 
standard  formula  defines  explicitly  which  risks  are  to  be  taken  into  account  in  the  SCR 
calculation.  By  contrast,  internal  models,  which  are  subject  to  supervisory  approval,  give 
insurance companies a high degree of flexibility. But there is a requirement to take into account 
all  material  quantifiable  risks  that  are  in  the  scope  of  the  model  in  the  determination  of  the 
regulatory capital requirement.  

Under  the  Solvency II  standard  formula,  any  securitisation 
is  subject  to  capital 
requirements related to spread risk in the calculation of the SCR. SBBS would therefore be 
subject to capital requirements for spread risk and put at a disadvantage relative to direct holdings 
of Member State central government bonds denominated and funded in domestic currency (which 
would not be subject to such requirements). 

A  general  look-through  approach  in  the  standard  formula  exists  under  Solvency II  for 
exposures  to  investment  funds,  but  not  for  securitised  products.  Nevertheless,  there  is  a 
“partial look-through” requirement resulting from the fact that securitisations have to be included 
in the calculation of the capital requirements for interest rate risk.  

Capital rules for pension funds are not fully harmonised at EU level. In particular, applying 
capital requirements to securitised products is at the discretion of national legislators.  

Liquidity and collateral 

While  all  euro  area  government  bonds  qualify  as  level-1  asset  under  the  EU’s  liquidity 
coverage  ratio  (LCR),  SBBS  would  not,  by  virtue  of  being  considered  as  securitisation 
positions. At present, senior tranches of asset-backed securities can be at best level-2b assets and 
subject  to  a  25%  minimum  haircut  under  specific  criteria  set  out  in  Commission  Delegated 
Regulation (EU) 2015/61. SBBS would not qualify for this treatment, since sovereign bonds are 
not  included  in  the  list  of  eligible  underlying  exposures.21  The  same  disparity  of  treatment 
between SBBS and their underlying sovereign bonds occurs as far as the net stable funding ratio 
(NSFR) is concerned, as the latter adopts the same definition of liquid assets as the LCR.  

SBBS would compare unfavourably to their underlying government bond also in terms of 
usability  as  collateral—a  key  determinant  of  financial  assets’  liquidity.  The  Financial 
Collateral Directive (Directive 2002/47/EC) makes no distinction between bonds and securitised 
products, meaning that it protects them legally in the same way. In practice, market data on the 
use of collateral in repurchase transactions suggest that only a small share of them use securitised 
assets as collateral (for example, securitised products are not part of any global collateral baskets 
of  major  clearing  houses  such  as  Eurex  and  LCH).  In  contrast,  government  bonds  are  used 
heavily as collateral and in securities lending. Utilisation rates are about 50% for German, 30% 
for French and 15% for Italian sovereign bonds.22 The extent to which SBBS could be usable as 
collateral is likely to be limited under the current regulatory framework, in part because they are 
not eligible as collateral in central bank operations23 (the latter is considered a necessary, but not 

21 Article 13(2)g of Commission Delegated Regulation EU No 2015/61. 
22 Using data from Markit Securities finance, the monetary advantage of being eligible for use as collateral 

would be around 15 basis points when euro area average fees for securities lending are taken as a proxy, and 
close to 20 basis points for German and French sovereign bonds. 

23 Government bonds are presently not foreseen in the list of eligible assets for eligible securitisations in the 

ECB’s collateral framework. Moreover, all securitisations presently command by default a 15% minimum 
haircut. 

11 

 
                                                      
sufficient,  condition  for  usability  as  collateral  in  private  repurchase  transactions—for  example 
central  securities  depositories  (CSD)  may  accept  instruments,  beyond  sovereign  bonds  or  other 
publicly  guaranteed  bonds,  if  these  are  eligible  at  a  central  bank  from  which  the  CSD  banking 
service provider has access to regular, non-occasional credit).  

Investment rules and restrictions 

For  several  types  of  investors,  positions  in  SBBS  may  be  subject  to  stricter  limits  than 
positions  in  sovereign  bonds.  As  a  general  rule,  banks,  insurance  companies,  but  also 
Alternative Investment  Fund Managers (AIFMD) and  undertakings for collective  investment in 
transferable  securities  (UCITS)  can  invest  in  securitised  products  only  if  originators  retain  a 
material  net  economic  interest.  SBBS  would  however  not  be  subject  to  this  limitation,  because 
they can be considered exposures to Member State central governments denominated and funded 
in the domestic currency of those central governments.24 However, the following restrictions do 
apply: 
  UCITS  need  to  respect  diversification  rules,  which  may  prevent  them  from  holding 
large volumes of SBBS. While Member States may authorise UCITS to invest up to 100% in 
transferrable  securities  issued  or  guaranteed  by  a  public  body,  this  exception  may  not  be 
available for SBBS.25  

  The Money Market Funds Regulation currently under negotiation26 may restrict money 
market  funds  from  investing  in  SBBS.  Although  the  focus  of  money  market  funds  on 
investments with short maturities suggests they are unlikely to be the main investors in SBBS 
across the entire term structure, they could still play a crucial role for the liquidity  of SBBS 
by accepting them as collateral in private repurchase transactions if this would be allowed.  
  Central  Counter  Parties  (CCP)  may  in  principle  be  able  to  invest  in  SBBS  under 
current  rules,  if  they  are  considered  to  be  highly  liquid.  In  line  with  their  investment 
policies,  however,  they  would  probably  not  be  able  to  invest  in  junior  SBBS  since  these 
securities would be perceived as too risky. 

  For  insurance  companies,  the  Solvency II  framework  sets  out  specific  due  diligence  and 

risk management requirements for securitisation positions.27  

  For IORPs,  Article 19 of Directive (EU) 2016/2341, to be transposed into national law 
by  2019,  sets  out  provisions  in  relation  to  the  prudent  person  rule,  including  limits  to 
excessive  risk  concentration.  Member  States  may  choose  not  to  apply  the  diversification 
requirements  to  investments  in  government  bonds.  Moreover,  Member  States  may  impose 
quantitative  restrictions  for  securitisations.  Article  25  of  Directive (EU) 2016/2341 
specifically  mentions  the  need  for  an  IORP’s  risk  management  system  to  address  in  a 
proportionate  manner  risks  which  can  occur  in  the  area  of  investments,  in  particular 
derivatives, securitisations and similar commitments, where applicable. 

2.2.  What are the problem drivers?  

The key driver of the problem is that the current regulatory framework of securitisations 
does not adequately take into account all the properties of SBBS. This is not surprising, 
considering that SBBS are a novel concept that does not yet exist. 

24 See, for example, Art. 255 of Commission Delegated Regulation EU No 2015/35. 
25 Directive 2009/65/EC (UCITS) imposes diversification on UCITS. Although Art. 54 derogates from Art. 52 
and the principle of risk-spreading to allow investments up to 100% in transferable securities issued by the 
same entity (i.e. same issuer or same guarantor), SBBS are currently not listed as possible beneficiaries of 
this exemption. Moreover, there is a requirement of diversification across different maturities. 

26 Commission proposal COM/2013/615. 
27 Art. 4(5) and (6) of Commission Delegated Regulation EU No 2015/35 requires insurance companies to 

produce their own internal credit assessment for type-2 securitisations. Art. 256 sets out due diligence and 
risk management requirements including stress testing for securitisations.  

12 

 
                                                      
In  the  current  regulatory  framework,  securitisation  products  attract  higher  regulatory 
charges/discounts  than  direct  investments  in  the  corresponding  underlying  assets.  The 
framework,  in  other  words,  is  not  neutral  between  investing  directly  in  some  assets 
vis-à-vis investing in structured products backed by these same assets. 

The general justification for such non-neutrality comes from securitisation-specific risks, 
having to do primarily with sharply asymmetric information between the originator of the 
securitisation  products  and  the  investors.  This  asymmetry  of  information  is  typically 
compounded  by  the  opaque  nature  of  the  securitised  assets  and  the  complexity  of  the 
structure.  

These risks include:  

  Agency  risk.  Originators  know  substantially  more  than  investors  about  the  assets 
composing the securitisation pool. This is obviously the case, e.g., with a bank that 
issues mortgages and then securitises them. An investor does not have access to the 
same  information  on  the  mortgage  borrowers  as  the  bank.  He/she  also  can  assume 
that the bank may have an incentive to securitise first/only the least profitable/more 
risky  mortgages.  It  is  because  of  this  agency  problem  that  many  institutional 
investors as well as banks are prevented from investing in securitisations unless the 
issuer retains a significant "skin in the game". 

  Model risk. As a result of tranching, pay-outs are non-linear (some investors are paid 
even  if  others  are  not).  This  generates  a  higher  sensitivity  of  the  price  of  the 
securitised  products  to  errors  in  estimating  probabilities  of  default,  losses  given 
default, and default correlations of the underlying assets.  

  Legal risks. These stem from the fact that there is an additional counterpart involved 
(i.e.,  the  arranger  of  the  securitisation)  and  the  complexity  of  the  product  (e.g., 
generating uncertainty as to the correct application of the payment waterfall under all 
future scenarios).  

Yet, SBBS are a sui generis securitisation along several key dimensions:  

1.  Many  of the asymmetries  of information and, to an extent, the complexities of the 
structure  are  not  present  when,  as  is  the  case  for  SBBS,  the  underlying  pool  is 
composed of euro area central government bonds. These assets are the workhorse of 
European  financial  markets.  They  are  well  known  and  understood  by  market 
participants.  Moreover,  the  structure  of  the  underlying  asset  pool  for  SBBS  would 
basically  be  predetermined  (e.g., in  the  basic  model,  the  weights  of  the  individual 
Member  States'  central  government  bonds  would  be  in  line  with  the  ECB  key). 
Hence  there  is  no  asymmetry  of  information  between  the  issuer  and  the  investor. 
Indeed, in theory, the issuer/assembler could be a robot. 

2.  Euro area sovereign bonds are also traded (which means, anyone can get a financial 
exposure to them without having to resort to a securitisation) and (for the most part) 
liquid  (both  de  facto  and,  equally  importantly,  de  jure—in  the  sense  that  they  are 
treated as such in regulation).  

This means that the securitisation-specific regulatory charges are not justified in the case 
of  a  securitisation  of  euro-area  sovereign  bonds  (especially  one  which  is  assembled 

13 

 
followed a pre-defined methodology/recipe, as is the case for the particular SBBS studied 
by the ESRB HLTF, and described in Box 1). 

Under the current regulatory framework, SBBS face a similar problem as that which has 
been addressed with the recent Simple, Transparent and Standardised (STS) regulation. 
Specifically,  the  rationale  for  the  recent  STS  regulation  is  that,  in  the  presence  of 
securitisations which are structured in a particularly simple, transparent and standardised 
way,  failing  to  recognise  such  properties  with  a  specific  (and,  in  practice,  more 
favourable) regulatory treatment would have hindered their development.  

Given the special nature of their underlying assets, namely euro-area central government 
bonds,  for  SBBS  the  wedge  between  the  regulatory  treatment  of  (traditional) 
securitisations and the actual risk/uncertainty of the instrument is even more pronounced 
than  was  the  case  for  STS  securitisations.  This  is  for  two  reasons:  (1)  the  underlying 
assets—namely,  euro-area  sovereign  bonds—are  even  more  simple,  transparent  and 
standardised;  and  (2) euro-area  sovereign  bonds  receive the  most  favourable  regulatory 
treatment in light of their properties and functions in the financial sector.  

In addition, investment decisions as regards government bonds are particularly sensitive 
to costs and fees (again, because of the volumes involved, the competition, their being in 
effect "benchmarks", etc.). Relevant costs, from the viewpoint of a financial institution, 
do include the cost of capital associated with the purchase of such assets. This means that 
failure  to  address  this  regulatory  issue  is  likely  to  have  a  correspondingly  greater 
impeding  effect  on  the  developments  of  the  market  for  SBBS  than  would  have,  for 
example, been the case for STS securitisations. 

Box 5: Why is regulatory non-neutrality a problem only for SBBS? 

Despite  facing  higher  regulatory  charges  (in  the  form,  e.g.,  of  surcharges  in  the  calculation  of 
capital  requirements  for  banks/insurance  companies,  or  limited/reduced  usability  of  structured 
products  as  collateral)  than  investing  directly  in  the  underlying  asset  pool,  market  participants 
typically do engage in assembling, marketing and investing in (traditional) securitisations, such 
as Mortgage-Backed Securities (MBS).  

This is because traditional securitisations create value by not only redistributing the credit risk of 
the  underlying  pool,  but  also  by  creating  liquidity.  Through  traditional  securitisation,  a  set  of 
assets  which  are  typically  individually  non-tradeable,  opaque,  and  risky,  can  be  repackaged  in 
tranches  with  different  economic  features.  In  particular,  the  senior  tranche,  by  virtue  of  the 
combined support from diversification of the underlying portfolio (which can reduce, and in the 
limit,  eliminate diversifiable risks)  and  the existence of a sub-senior tranche acting as first-loss 
absorber,  can  become  a  highly-rated,  tradeable  and  liquid  asset.  Thus,  through  securitisation, 
even  an  investor  who  is  restricted  –  by  either  the  law  or  its  individual  investment 
mandate/charter –  to  invest  only  in  liquid  and  highly-rated  assets  can  gain  exposure  to  projects 
(e.g.,  mortgages)  which  individually  would  not  have  had  these  required  properties.  Hence  this 
investor may be willing to incur the regulatory charges associated with a securitisation tranche if 
he/she  values  high  ratings  and  liquidity  sufficiently.  Moreover,  and  importantly,  for  some 
underlying assets (in particular, non-traded mortgages or loans issued by a bank), an investor may 
simply  have  no  other  way  of  securing  an  exposure  than  indirectly  by  buying  a  stake  in  the 
structured product backed by such assets. 

These  supporting  considerations  do  not  apply  to  SBBS  securitisations,  given  their  sui  generis 
nature.  In  particular,  since  the  underlying  assets,  i.e.  euro  area  central  government  bonds,  are 
individually tradeable and liquid, there is no need to resort to a securitisation to gain exposure to 
such instruments, nor can one, by doing so, gain in terms of, say, liquidity – indeed, if anything, 

14 

 
it is quite likely that until and unless an SBBS market of sufficient size develops, each individual 
underlying bond would be more liquid than any of the SBBS tranches. 

In  sum,  securitisation  in  the  case  of  SBBS  only  serves  as  a  tool  to  concentrate  the  risk  of  the 
underlying  sovereign  portfolio  in  one  instrument  (the  junior  tranche),  and  relieve  of  it  from 
another  (the  senior  tranche).  But  there  is  not  much  scope  for  improving  on  the  ratings  of  the 
safest  of  the  underlying  assets,  nor  to  create  liquidity.  Thus,  unless  SBBS  securitisations  are 
granted  the  same  treatment  as  their  underlying  sovereign  bonds,  they  will  not  be  produced  or 
demanded by the private sector. 

2.3.  How will the problem evolve? 

In  the  baseline  (with  no  intervention)  the  regulatory  hindrances  deriving  from  the  gap 
between the regulatory treatment of SBBS and that of their underlying sovereign bonds 
may diminish somewhat over time, in particular for banks, but are unlikely to disappear 
altogether. 

In  particular,  the  recent  revision  of  the  CRR  (Regulation  (EU)  2017/2401),  which  is 
expected to come into effect in 2019, could result in reduced regulatory surcharges faced 
by  SBBS  vis-à-vis  government  bonds  in  terms  of  Pillar-1  capital  requirements. 
Specifically,  under  certain  conditions  (see  footnote  18),  senior  tranches  may  be  able  to 
benefit from a  zero risk weight after application of the "look-through" principle, which 
will be possible not just for banks sponsoring/originating securitisations – as is currently 
the  case  –  but  also  for  banks  investing  in  them.  Non-neutrality  for  Pillar-1  capital 
requirement purposes would be established also for sub-senior tranches for the subset of 
banks  using  Internal-Ratings  Based  models  (IRBA-banks),  but  not  for  others.28 
Nevertheless, important sources of unfavourable regulatory treatment  – most notably in 
terms of liquidity-related regulation – would remain, including for the senior SBBS. 

The HLTF report points out that, if RTSE were to be reformed and, for example, capital 
charges  for  banks'  sovereign  exposures  were  to  be  introduced  and  made  sensitive  to 
concentration or credit risk, senior SBBS may become more attractive, compared to their 
underlying sovereign bonds, for banks by virtue of SBBS' greater diversification/safety. 
This  might  offset  some  of  the  regulatory  hindrances  associated  with  "undue" 
securitisation-related  additional  regulatory  charges.  At  the  same  time,  the  report  notes 
that this finding does not pertain to the overall merits or demerits of RTSE reform. 

Therefore, for the baseline, we assume no RTSE change would take place. This is also in 
line with the conclusion of the discussions at international level (in the Basel Committee 
on  Banking  Supervision).29  Any  reform  of  RTSE  would  have  profound  implications  in 
terms  of  financial  stability.  Thus  the  European  Commission  has  clearly  stated  that  it 
considers  that  a  reform  of  the  prudential  treatment  of  sovereign  exposures  can  only 
happen  after  several  pre-conditions  are  in  place,  including  a  full  Banking  Union  and 
substantial  progress  towards  a  Capital  Markets  Union  and  the  existence  of  a  European 

28 See section 2, Annex 4 for some quantitative indication of the extent of the problem even after the entry into 

force of the new securitisation framework per regulation (EU) 2017/2401, expected for 1/1/19. 

29 The issues discussed are summarised by the Basel Committee in the December 2017 Discussion Paper on "The 

regulatory treatment of sovereign exposures" available at https://www.bis.org/bcbs/publ/d425.htm. In 
presenting it, the Committee notes that it "has not reached a consensus to make any changes to the treatment 
of sovereign exposures, and has therefore decided not to consult on the ideas presented in this paper." 

15 

 
                                                      
safe asset. In addition, if a level playing field for Europe’s financial sector is desired, an 
agreement at the global level would also be essential. 

A European safe asset, a new financial instrument for the common issuance of debt, is a 
necessary step in the completion of the EMU architecture (European Commission, 2017). 
It  would  need  to  be  sizeable  enough  to  become  the  benchmark  for  European  financial 
markets,  and  create  a  large,  homogenous  and  liquid  EA-level  bond  market,  avoiding 
sudden  stops  and  financial  fragmentation, and  increasing  the  total  European  and  global 
supply of safe assets. The Commission will further reflect on different options for a safe 
asset for the euro area in order to encourage a discussion on the possible design of such 
an  asset,  separately  from  the  present  discussion  on  the  introduction  of  an  enabling 
framework for SBBS. 

As  regards  insurance  companies  and  other  asset  managers,  no  changes  are  expected  in 
the baseline as regards the regulatory disincentives/limits to hold SBBS as opposed to the 
underlying sovereign bonds.  

In  a  nutshell,  Figure 4  summarises  the  elements  of  the  "problem  tree"  (i.e.,  problem, 
driver, and consequences), as described in section 2. 

Figure 4: The Problem Tree 

Drivers 

Problems 

•D1. The current 
regulatory framework 
does not adequately 
capture all the 
properties of SBBS 

•P1. SBBS face "extra" 
regulatory charges and 
discounts when 
compared to their 
underlying sovereign 
bonds  

Consequences 

•C1. There are 
unwarranted 
disincentives for the 
private sector to 
assemble, sell and/or 
invest in SBBS 

•C2 No sizeable market 
for SBBS can emerge 

3.  WHY SHOULD THE EU ACT? 

3.1.  Legal basis 

SBBS are a tool to enhance financial stability and risk sharing across the euro area. They 
can  thus  contribute  to  the  better  functioning  of  the  internal  market.  Article  114  TFEU, 
that  confers  to  the  European  institutions  the  competence  to  lay  down  appropriate 
provisions that have as their objective the establishment and functioning of the internal 
market, is thus the appropriate legal basis.  

16 

 
 
 
3.2. 

Subsidiarity (Necessity of EU action) 

Identified regulatory impediments to the development of SBBS markets are laid down in 
several pieces of EU legislation (e.g. Regulation (EU) 575/2013 (CRR) on the prudential 
treatment  of  credit  risk  or  market  risk  for  banks;  Delegated  Regulation  (EU) 2015/35 
(Solvency  II)  on  spread  risk  on  securitisation  positions  for  insurance  companies;  or 
Directive  2009/65/EC  (UCITS),  on  eligibility  criteria,  concentration  limits  and 
diversification requirements for UCITS). As a consequence, on a point of law, individual 
Member State action would not be able to achieve the goals of this legislative initiative, 
i.e.  to  remove  such  regulatory  impediments,  since  amendments  of  EU  legislation  can 
only be done through EU action.  

But even aside from this legal consideration, action at the Member States' level would be 
suboptimal. It could result in different instruments being "enabled" in different Member 
States. This would render the market rather opaque and split market demand in various 
different instruments, which would make it difficult (or even impossible) for any one of 
them to acquire the requisite standing in terms of size and liquidity. Furthermore, even if 
national legislators would address the same instruments by steps to remedy the currently 
disadvantageous  regulatory  treatment,  a race  between national legislation could emerge 
to  offer  as  favourable  as  possible  regulatory  treatment.  Furthermore,  in  both  cases,  i.e. 
addressing  differently  defined  products  or  giving  different  regulatory  treatment,  such 
different  national  legislations  would  create  de  facto  obstacles  to  the  Single  Market 
(e.g., high  compliance  costs  for  an  arranger  that  would  want  to  operate  in  multiple 
jurisdictions). For all these reasons, action at the EU level is necessary and appropriate. 
These  obstacles  would  have  sizeable  effects,  given  the  very  high  integration  of  the 
underlying  government  bond  markets  and  the  identical  regulatory  treatment  of  these 
across the EU. 

3.3. 

Subsidiarity (Value added of EU action) 

Establishing  an  appropriate  regulatory  framework  for  this  novel  product,  which—as 
mentioned above, can only be done via action at the EU level—has value added insofar 
as it may enable the development of an additional market through which financial risks 
can be better shared, thus promoting financial stability as well as lower overall borrowing 
costs for sovereigns and private sector agents. 

4.  OBJECTIVES: WHAT IS TO BE ACHIEVED? 

4.1.  General objectives 

The general objective is to remove identified regulatory impediments against a (privately 
produced,  not  mutualised)  liquid,  low-risk  asset,  such  as  the  (senior)  SBBS.  Such  an 
asset  could  facilitate  private  sector  risk  sharing—especially  across  borders—and  risk 
reduction. This would strengthen the Banking Union.  

In particular, as summarised in Box 1 and discussed at greater length in Brunnemeier et 
al  (2016b),  ESRB  HLTF  (2018a)  and  ESRB  HLTF  (2018b),  a  pan-euro  area  low-risk 
asset  such  as  the  senior  SBBS  could  facilitate  the  diversification  of  euro  area  banks' 
sovereign  portfolios.  This  would  reduce  the  extent  of  "home  bias"  in  banks'  balance 

17 

 
sheets, which despite recent progress remains rather high in some Member States. This, 
in turn, would foster stability in the euro area: it would weaken the nexus between banks 
and  their  sovereign  and  it  would  spread  perceived  idiosyncratic  sovereign  risk  more 
widely across borders within EMU.  

A  low-risk  asset  like  the  (senior)  SBBS  could  also  help  avoid  that  exogenous  capital 
flows in search of "safety" affect the cross-section of euro area funding costs in an overly 
unequal manner, as in practice is the case at present since only sovereign bonds of a few 
Member States are at present perceived to be very low risk. It could also help address the 
increasing relative scarcity of euro-denominated low-risk/high-rated assets resulting from 
increasing  demand  for  such  assets—also  due  to  regulatory  requirements  on  financial 
institutions  (e.g.  Liquidity  Coverage  ratio  (LCR),  Net  Stable  Funding  Ratio  (NFSR), 
etc.)—against  a  background  in  which  the  assessed  creditworthiness  of  several  EU  and 
euro area Member States has deteriorated in the wake of the global financial crisis.  

Importantly,  such  an  asset  is  meant  to  be  solely  based  on  private-sector  initiatives, 
without the possible  support  of  any (perception of)  mutualisation  of  risks  and/or  losses 
among EU Member States. This is a key desideratum, and will need to be kept in mind in 
determining the specific content of any proposed initiatives. 

4.2. 

Specific objectives 

For an asset like the SBBS to be "enabled", the following two objectives would have to 
be achieved: 

1.  Eliminate undue regulatory hindrances (i.e., restore regulatory "neutrality" for SBBS 

securitisations).  

2.  Encourage  liquidity  and  "benchmark"  quality  (i.e.,  the  new  instrument  should  be 
treated  like  other  benchmarks  in  regulation—de  jure  liquidity—and  should  be 
capable of attaining a sufficient critical mass/standardisation so as to be liquid also 
de facto). 

Importantly,  removing  undue  regulatory  hindrances,  by  assuring  that  the  product  is 
treated  as  its  underlying  government  bonds,  is  only  a  necessary  condition  for  the 
development of such markets, but does not guarantee it—after all, SBBS are meant to be 
developed  by  the  private  sector.  The  actual  development  of  such  a  market,  after  the 
removal of identified regulatory hindrances, will rather depend on the economic viability 
of the product, i.e. on whether it will be advantageous for investors to acquire them and 
private  arrangers  to  issue  them—this  in  turn  depends  on  the  extent  to  which  the  new 
products  would  become  "benchmarks"  and  easily  traded,  among  other  considerations 
(e.g.,  the  strength  of  the  demand  for  sub-senior  tranches,  etc.).  The  HLTF  report  has 
extensively analysed the issue and concluded that ultimately only a "market test" would 
be able to settle remaining doubts as to the viability of SBBS. The specific objective of 
the proposed regulatory framework is indeed to enable such a market test. In contrast, the 
regulation  will  not,  as  discussed  further  in  Section  5.3  below,  provide  incentives  to  the 
development  of  SBBS  markets,  besides—that  is—removing  identified  regulatory 
obstacles. 

18 

 
5.  WHAT ARE THE AVAILABLE POLICY OPTIONS? 

Given the problem definition above, the first policy choice to be made is between keeping 
the status quo (i.e. "do nothing", or baseline) versus introducing a legislative proposal to 
enable the development of SBBS market ("an enabling framework for the development of 
SBBS," in the language of President Juncker's September 2017 Letter of Intent).  

If it is found opportune to introduce such a legislative proposal, two main policy choices 
would need to be made, namely on the scope of applicability of the proposed legislation 
and on the extent to which the legislation should enable the various tranches. Given this, 
five  main  "models"  for  the  proposed  legislation  are  seen  as  deserving  in-depth 
consideration (see Figure 5). Separately, a third key policy choice has to be made as to 
how  to  ensure  compliance  with  the  proposed  new  legislation  itself.  Here  three  options 
are assessed, i.e. self-certification on its own, or complemented, respectively, with a third 
party assessment or ex-ante supervisory approval.30 

5.1.  What is the baseline from which options are assessed? 

The baseline is the status quo, i.e. no legislative intervention and unchanged RTSE (see 
earlier discussion on page 15). In this scenario, SBBS are likely to remain an interesting 
theoretical construct, but would not be produced and made available to investors. This is 
because  they  would  face  significant  additional  regulatory  charges  (e.g.,  in  terms  of 
required  capital),  discounts  (e.g.,  in  terms  of  eligibility  for  liquidity  requirements),  and 
limits  (in  terms  of  investability  for  some  market  players)  as  compared  with  their 
underlying  sovereign  bonds,  which  will  render  them  unappealing  or  prohibitively 
expensive.  

To  gauge  the  extent  of  regulatory  hindrance  faced  by  SBBS  in  the  baseline,  the  HLTF 
report shows that, if the banks covered by the EBA 2015 Transparency Exercise were to 
switch all their current holdings of euro-area sovereign bonds into senior SBBS tranches 
today  (so  without  an  "enabling"  regulatory  framework  in  place),  they  would  face  an 
increase in aggregate capital requirements in the order of EUR 70 billion (see Annex 4, 
Section  1).  Of  course,  this  is  just  a  gauge,  and  less  extensive  switches  would  result  in 
correspondingly lower capital requirements. At the same time, if banks also bought sub-
senior tranches, which currently would face much higher risk weights than senior ones, 
the capital requirement implications could also be much larger.  

These  hurdles  are  likely  to  remain  even  after  taking  into  account  some  regulatory 
changes which are already in the pipeline, e.g. those stemming from the recent revision 
of  the  securitisation  framework  (Regulation  (EU)  2017/2401),  due  to  become  effective 
on  1/1/2019.  Regulation  (EU)  2017/2401  foresees  reduced  capital  requirements  on 
securitisation  positions  for  banks  provided  they  are  at  all  moments  perfectly  informed 
about the composition and risk features of the underlying assets—this condition is likely 
to  be  easily  satisfied  for  SBBS  (especially  if  the  latter  have  a  narrowly  defined 
"recipe"—see below). Nevertheless, the subset of banks using the Standardised Approach 

30 The problem of how to ensure compliance with a legislation that dictates a specific treatment for a subset of 

securitisations has already been addressed in the context of the regulation on Simple, Standard, and 
Transparent securitisations (STS). Thus a similar approach will be used here. 

19 

 
                                                      
(henceforth,  "SA  banks")  would  still  face  large  capital  requirements  when  holding 
sub-senior tranches under the baseline after 1/1/2019. Section 2 of Annex 4 shows that, 
for each EUR 100 billion of investment in SBBS, assuming SA banks purchase the three 
tranches in a balanced manner and in line with their current share of sovereign bonds in 
the  banking  book,  aggregate 
increase  by  some 
EUR 87 billion (this number would need to be multiplied by a capital requirement ratio, 
typically in the range of 8-13 percent, to arrive at the implications of the investment in 
SBBS for capital requirements). 

risk-weighted  assets  would 

Against  this  baseline,  the  alternative  option  is  to  intervene  by  proposing  an  "enabling" 
regulatory framework that adequately reflects the unique nature of securitisations issued 
against  a  portfolio  of  euro  area  sovereign  bonds.  This  option  can  take  different 
declinations,  depending  on  the  desired  extent  to  which  SBBS  are  equated—in  terms  of 
regulatory treatment31—to their underlying components (i.e. euro-area sovereign bonds) 
and on how precisely one goes about designing any such desired regulatory treatment in 
practice. 

In his Letter of Intent accompanying his September 2017 State of the Union Address to 
the European Parliament, President Juncker has committed the European Commission to 
introduce an "enabling framework" for SBBS, in other words to move past the baseline 
of no intervention.  

This course of action is dictated by the potential benefits associated with the concept of 
SBBS.  Although  whether  or  not  SBBS,  once  freed  of  existing  regulatory  impediments, 
will actually take off is difficult to predict, the fact remains that the benefits, in expected 
terms (i.e., weighted by the probability of them actually materialising), that would stem 
from  the  development  of  a  market  for  SBBS  far  outweigh  the  cost  of  introducing  the 
enabling framework.  

Aside from the one-off direct costs of introducing the product regulation (which, it bears 
recalling,  in  effect  recalibrates  existing  regulations  to  allow  for  a  completely  new 
product),  other  possible  costs  would  stem  from  "unintended  consequences"  of  a 
developed SBBS market. Importantly, when assessing such possible costs and risks, one 
has to distinguish between those which result (or are intensified) directly by the existence 
of  SBBS  in  financial  markets,  from  those  that  would  happen  as  a  reflection  of 
developments in the fundamentals of the underlying sovereign bonds, which would likely 
affect SBBSs but that would occur regardless of whether SBBS are in the market or not. 
For  the  latter  set  of  costs/risks,  the  relevant  yardstick  of  comparison  is  whether  the 
presence of SBBS aggravates them or not.  

In  the  former  category  (i.e.,  risks  stemming  directly  from  the  development  of  SBBS 
markets), the key one considered both by the HLTF and for this impact assessment has to 
do  with  the  possibility  (flagged,  in  particular,  by  euro-area  Debt  Management  Offices) 
that packaging a lot of a given government's bonds into SBBS could adversely affect the 

31 Note that extending the regulatory treatment of euro-area sovereign bonds to any given SBBS tranche would 
be tantamount to addressing, for that specific tranche, all dimensions of currently differential treatment as 
described in Box 4. 

20 

 
                                                      
liquidity of the bonds of said government that remain outside of the SBBS construct. The 
HLTF  has  analysed  at  length  the  likely  effects  of  SBBS  on  the  liquidity  of  national 
sovereign debt markets and it has concluded that, certainly for moderately-sized volumes 
of SBBS, these are likely to be limited (see, in particular, Volume II, section 4.4 of the 
ESRB HLTF report and Annex 4.3 of this impact assessment).  

In  the  latter  category  (i.e.,  risks  that  stem  from  possible  developments  in  the 
fundamentals of underlying sovereign bonds, e.g. causing the loss of the AAA rating for 
the  senior  SBBS  tranche),  the  key  question  is  whether,  in  a  crisis  circumstance,  the 
presence of SBBS is stabilising or destabilising. Note that it is quite possible that, during 
an episode of turbulence linked to marked deterioration in the creditworthiness of one or 
more  euro  area  sovereigns,  it  may  become  difficult  or  even  impossible  to  assemble 
SBBS,  presumably  because  there  will  be  no  demand  for  the  junior  tranche  in  those 
circumstances. (In extreme circumstances, the senior tranche might also be downgraded). 
But this would still leave those sovereigns who do remain creditworthy able to issue their 
own  bonds,  while  for  the  others  the  problem  would  not  be  different  than  if  SBBS  had 
never  been  created.  Even  if  volume  of  SBBS  (temporarily)  stops  growing  in  such  a 
circumstance,  the  stock  of  already  issued  SBBS  may  still  prove  helpful  in  channelling 
financial flows from across national borders (as happens at present, with investors fleeing 
Member  States  in  trouble  and  seeking  safe  haven  in  "core"  Member  States)  to  a 
"cross-instrument"  pattern  (i.e.,  from  the  junior  to  the  senior  tranches).  This  would  be 
less damaging to the integrity of the euro area. Moreover, bonds packaged in the already 
issued  SBBS  would  not  be  "available  for  sale",  which  would  in  itself  provide  some 
stabilisation ("fire sale"-driven spikes in individual Member States' funding costs would 
be avoided).  

Others  have  argued  against  an  enabling  regulatory  framework  on  the  ground  that  the 
product is not viable. For instance, no private issuer may deem SBBS to be sufficiently 
profitable, or there may not be sufficient demand for the junior tranche. In our view, this 
is  no  grounds  not  to  rectify  the  identified  regulatory  "failure".  Rather,  it  would  just 
indicate that the above-mentioned "market test" would not have (yet) been successful.32  

On the basis of the above arguments, this assessment concludes that the Commission has 
no option but to propose an "enabling framework" and that indeed doing so generates, in 
expected  terms,  a  net  social  gain.  Section  5.2  describes  the  intervention  options 
considered, while section 5.3 describes options which have been discarded after careful 
consideration. 

32 Once regulatory impediments have been eliminated, demand (and thus the development of the SBBS market) 
could still take place in the future if, say, the overall euro-area/global macroeconomic environment turns 
more supportive. 

21 

 
                                                      
5.2.  Description of the policy options  

Option 

Description 

1. Scope of applicability of the proposed legislation 

1.1  Only SBBS proper   Only securitisations of euro-area sovereign bonds that comply 
with the SBBS recipe (see Box 6), i.e. whereby the underlying 
portfolio comprises all euro-area sovereign bonds with respective 
weights in line with the ECB capital key (rebased, as necessary, to 
exclude Member States that either have no or too little 
outstanding debt or might have lost market access) and which 
have tranching levels such that the senior tranche is "low-risk" 
(e.g., the senior tranche is not greater than 70%)33. 

1.2  All securitisations of 
euro-area sovereign 
bonds 

Any securitisation of euro-area sovereign bonds, regardless of the 
composition of the underlying portfolio and/or the number and 
levels of tranches, would be eligible for the regulatory treatment 
envisaged in the proposed product legislation. 

1.3  A basket of euro-area 

sovereign bonds (no 
tranching) 

Claims on an investment fund which invests fully in a basket of 
euro-area sovereign bonds, with respective weights in line with 
the ECB capital key (rebased, as necessary, to exclude Member 
States that have no outstanding debt and those who have lost 
market access), without tranching. 

2. Extent of "restored" regulatory neutrality 

2.1  Extend the regulatory 
treatment of euro-
area sovereign bonds 
to all tranches 

All tranches of the products eligible for the proposed legislation 
would be given a treatment comparable to that of euro-area 
sovereign bonds (in particular, no capital requirements, level-1 
eligibility for LCR/NFSR purposes, no concentration 
charges/limits, no investment restrictions. 

2.2  Extend the regulatory 
treatment of euro-
area sovereign bonds 
only to senior 
tranches 

Only the senior tranche of the products eligible for the proposed 
legislation would be given a treatment comparable to that of euro-
area sovereign bonds (in particular, no capital requirements, level-
1 eligibility for LCR/NFSR purposes, no concentration 
charges/limits; no investment restrictions). Sub-senior tranches 
would, instead, have additional charges, liquidity discounts, 
concentration charges, and investment limits. 

3.1  Introduce a self-
attestation 
mechanism 

3. Compliance mechanism 

Responsibility for compliance with the criteria envisaged in the 
legislation will lie with the originator of the securitisation. 

3.2  3.1 + third-party 
assessment 

Self-attestation by the originator, complemented by assessment 
provided by an independent third party. 

3.3  3.1 + ex-ante 

supervisory approval 

Self-attestation by the originator, complemented by ex-ante 
supervisory approval. 

33 See footnote 9 for an explanation of how the 70% threshold is arrived at in the HLTF report. 

22 

 
                                                      
5.3.  Options discarded at an early stage 

Regulatory incentives 

In addition to the options set out above and discussed in more detail below, a related but 
different  one  has  been  considered,  namely  going  beyond  the  mere  levelling  of  the 
regulatory playing field for SBBS by providing them the same treatment as for sovereign 
bonds,  to  actually  providing  them  a  preferential  regulatory  treatment  (i.e.,  outright 
regulatory incentives). 

The  main  advantage  of  such  approach  is  that  the  demand  for  SBBS  would  be 
correspondingly boosted and the potential benefits of SBBS would materialise faster and 
at a larger scale.  

There  are  two  main  drawbacks,  however.  First,  using  the  regulatory  framework  to  the 
advantage  of  this  new  product  could,  at  least  in  a  transition  phase,  destabilise  (some) 
national  debt  markets,  as  demand  for  SBBS  might  replace,  rather  than  complement, 
demand for stand-alone national sovereign bonds. Second, regulatory incentives could be 
seen as a signal that the Commission, and more generally the European authorities, stand 
ready  to  bail  out  investors,  should  these  novel  structured  products  encounter  problems. 
Such expectations would be highly detrimental, as they could lead to moral hazard on the 
part of Member States and of investors.  

On  the  basis  of  the  above  considerations,  such  an  option  has  been  discarded.  The 
proposed  legislation  would  aim  at  treating  SBBS  as  much  as  possible  as  euro-area 
sovereign bonds (i.e., restore "regulatory neutrality"), but not better/more favourably. 

Public issuance 

A second option, discarded after careful consideration, is that of a public issuer/arranger 
for  SBBS  (this  could  be  either  an  existing  institution,  such  as  the  ESM,  or  a  newly 
created  public  SPV).  A  public  arranger  could  benefit  from  economies  of  scale  (which 
would  ease  the  viability  test  for  SBBS)  and  may  meet  greater  confidence  from  market 
participants  from  the  very  start.  However,  entrusting  a  public  authority  with  such  task 
would shift a well-established private-sector activity to the public sector. This might also 
mean  that  the  possible  link  and  synergies  of  such  activity  with  that  of  (private-sector) 
market-making of government bonds could not be reaped.  

Furthermore,  deploying a  public  issuer  could  also  result  in  some  mutualisation  of  risks 
(for example, in  terms  of warehouse risk  for any period  between  the assembling of  the 
SBBS  portfolio  and  the  selling  of  all  the  tranches),  which  could  result  in  moral  hazard 
(this  concern  has  been  raised  by  several  observers/stakeholders,  including  Debt 
Management  Officers—see  Annex 2).  Also,  a  public  arranger  would  need  some  funds 
(for example a one-time fixed endowment of a limited quantity of paid-in capital) for the 
purpose  of  assembling  SBBS  cover  pools.  Providing  a  public  arranger  with  any  public 
funding  or  support  may  increase  the  risk  that  market  participants  misperceive  such 
activity as providing an implicit guarantee for SBBS payment flows.  

23 

 
 
On  the  basis  of  the  above  considerations,  such  an  option  has  been  discarded.  The 
proposed  legislation  would  aim  at  removing  the  impediments  for  private  sector 
production/use  of  SBBS.  Once  again,  it  bears  reminding  that  removing  the  identified 
regulatory  impediments  enables  the  development  of  this  novel  private  financial 
instrument, but in no way guarantees it. It may well be the case that, quite aside from the 
too  costly/insufficiently 
regulatory 
remunerating for the private sector. The viability of SBBS might also be a function of the 
more  general  economic  backdrop,  e.g.,  the  level  of  interest rates  and/or  expected  fiscal 
and real developments. 

framework,  assembling  SBBS  will  prove 

6.  WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? 

6.1. 

Scenarios and benchmarks of benefits and costs 

6.1.1.  Scenarios 

To cater for a wide range of possibilities, the impact of different intervention options has 
been  assessed under two different scenarios: a  limited volume scenario, whereby  SBBS 
reach an overall volume of EUR 100 billion, and a steady state scenario whereby SBBS 
reach an overall volume of EUR 1,500 billion.34 The final scale of the SBBS market will 
depend on the instruments' overall attractiveness for the market, given that the legislative 
intervention  is  only  a  necessary  but  not  necessarily  sufficient  condition  for  SBBS's 
development.  

6.1.2.  Benchmarks of benefits and costs 

As  regards  the  choices  with  respect  to  the  scope  of  applicability  of  the  proposed 
legislation (section 6.2 below) and the extent to which the regulatory treatment afforded 
to  euro  area  sovereign  bonds  (henceforth,  "benchmark"  regulatory  treatment)  is  also 
provided  to  the  various  SBBS  tranches  (section  6.3  below),  the  following  benefits  and 
costs have been assessed:  
- 
- 
- 
- 
- 

reduction in capital requirements (benefit); 
reduction in liquidity of national sovereign debt markets (cost);  
impact on volume of sovereign bonds rated AAA (benefit/cost); 
reduction in holdings of domestic sovereign bonds (benefit); 
impact  on  share  of  sovereign  bonds  rated  AAA  in  banks'  balance  sheets 
(benefit/cost); 
facilitating  cross-border  integration  and  the  reduction  of  asymmetric  shocks 
(benefits). 

- 

The benchmarks used are the evolution in % compared to the baseline scenario (current 
situation), or the amount of regulatory hindrance faced in the baseline (no intervention) 
by SBBS instruments, except for the liquidity of national debt markets as well as the last 

34 Both scenarios are considered in the HLTF report. In particular, as regards the steady state scenario, the HLTF 
considers an amount of EUR 1,500 billion as indicative of the size that an SBBS market could achieve while 
maintaining an adequate secondary market free float in national sovereign bond markets.  

24 

 
                                                      
criteria  (integration  of  capital  flows  cross-border),  where  the  analysis  remains  mainly 
qualitative. 

For the third key choice, i.e., the certification model (section 6.4 below), the main benefit 
to be assessed is the increased investor confidence while costs include both the potential 
moral  hazard  and  the  administrative  burden  for  stakeholders.  The  assessment  remains 
mainly qualitative for that option.  

6.2. 

Scope of applicability of the proposed legislation 

This section describes and assesses the scope of applicability of the product legislation, 
i.e. the range of sovereign bond-backed securities to which the legislation would apply. 
The  two  polar  options  are,  thus,  applying  the  proposed  product  legislation  to  any 
securitisation of sovereign bonds, or only to a particular combination of sovereign bonds 
(whether tranched or in a "simple" basket). 

6.2.1.  Option 1.1: only SBBS proper 

Option 1.1 deals with one extreme, where the legislation would be made applicable only 
to SBBS proper, i.e. securitisations of euro area sovereign bonds which meet the official 
"SBBS recipe".  

Box 6: The SBBS structure 

A set SBBS structure (i.e., a methodology  to assemble SBBS), e.g. a fixed portfolio of euro area 
sovereign  bonds  with  known  weights  (e.g.,  in  line  with  the  ECB  capital  key—see  Box 1)  and 
specified tranching points, is helpful to create a standardised product, which in turn enhances the 
product's appeal (e.g., in terms of liquidity).  

However, there may be circumstances in which some changes in this set structure are warranted. 
For example, an EU Member State  may  join the euro area. Or a Member State issues too  little 
debt,  so  that  it  becomes  difficult  if  not  altogether  impossible  for  arrangers  to  acquire  the 
necessary amount of bonds of that Member State as prescribed by the current structure. Or it may 
be  necessary (respectively,  possible)  to reduce  (resp.,  increase)  the  size  of  the  senior  tranche  if 
the ratings of the underlying euro area sovereign bonds deteriorate (resp., improve).  

For such exceptional cases the regulatory framework should foresee safeguards, which allow for 
controlled and limited modifications of the set SBBS structure. The trade-off is between adapting 
the product to the changed reality and safeguarding standardisation. Efficiency will likely call for 
minimizing the changes to the set structure as much as possible. 

Who would set the SBBS structure and through what procedure would it be changed?  

There are in principle three avenues:  
1. A  public  agency  (e.g.,  ESMA)  could  be  tasked,  in  the  enabling  regulation,  to  spell  out  the 
initial SBBS recipe and to propose adjustments to it when necessary. These proposals would 
be akin to regulatory technical standards, which are approved by the Commission. 

2. The  Commission  itself  could  define  and  adapt  the  official  SBBS  recipe  by  way  of 

Implementing Decisions. 

3. Alternatively, a private entity (e.g., a consortium of arrangers) could set out, and change as 

appropriate, the "standard" for the SBBS product. 

These  avenues  will  be  explored  in  the  drafting  of  the  legislative  proposal,  with  a  view  to 
maximize  the  likely  chance  of  success  of  the  product  (including  by  underpinning  market 
confidence  and  legal  certainty,  e.g.  with  respect  to  its  eligibility  for  the  proposed  regulatory 
treatment) and minimize administrative burden. 

25 

 
Should the product legislation apply only to SBBS proper, thanks to the ensuing induced 
standardisation, a sizeable market for this particular instrument is likely, although by no 
means certain, to develop. This, in  turn, could enhance  liquidity and appeal of the new 
instrument,  and  provide  greater  incentives  for  banks  and  other  financial  institutions  to 
invest in them. This prospect in itself may be an important factor in generating sufficient 
demand.  So,  a  narrower  scope  of  applicability  of  the  proposed  legislation  may  be 
’enabling’ in and of itself, as far as the ultimate development of SBBS is concerned (see 
responses to the public survey on liquidity and standardisation in Annex 2, section 1). 

One critical feature of the SBBS proper is the tranching of the instrument which should 
ensure  that  the  senior  tranche  is  granted  a  AAA  rating  (note  that  this  may  require 
adjusting the size of the tranche over time in response to future economic, financial and 
political  developments  –  see  Box 6).  Assuming  the  senior  tranche  at  a  70%  tranching 
point  is  granted  a  AAA-rating  (i.e.,  is  considered  as  safe  as  the  safest  assets  in 
circulation),  the  Commission's  analysis  (see  section 4  in  Annex 4)  shows  that  the 
introduction of the SBBS could increase the volume of AAA sovereign bonds available 
in  the  euro  area  by  some  2%  (in  the  limited  volume  scenario)  and  up  to  30%  (in  the 
steady state scenario) compared to the baseline with no legislative initiative and thus no 
SBBS.  

Under this option, the impact on the diversification of banks' sovereign portfolios would 
range  from  a  reduction  by  3%  of  domestic  sovereign  holdings  to  a  reduction  of  those 
holdings  by  34%,  depending  on  the  scenario  (limited  volume  vs  steady  state  scenario). 
Similarly,  the  share  of  government  bonds  rated  AAA  on  banks'  balance  sheets  would 
increase  by  about  40%  under  the  steady  state  scenario  (from  24%  to  32%  or  33% 
depending on the regulatory treatment), but remain roughly unchanged under the limited 
volume scenario (see section 4, Annex 4). 

A  key  concern  raised  by  several  stakeholders  is  that  SBBS  might  adversely  impact  the 
liquidity  of  national  sovereign  debt  markets.  These  concerns  are  the  more  relevant  the 
smaller the national sovereign bond market (this is, e.g., in particular the case for small 
Member  States)  and  the  larger  the  overall  volume  of  SBBS.  Given  the  importance  of 
such  concerns,  the  HLTF  has  conducted  an  in-depth  analysis,  which  is  summarised  in 
Section 3,  Annex 4. The main conclusion  is that the ultimate impact on the liquidity of 
the  national  sovereign  bond  market  results  from  two  opposing  channels:  On  the  one 
hand,  as  the  size  of  SBBS  market  increases,  the  liquidity  for  the  remaining  national 
bonds  outside  the  SBBS  scheme  could  suffer  because  of  the  reduction  in  the  residual 
outstanding  float.  On  the  margin,  this  could  lead  to  higher  funding  costs  for  the  most 
affected  Member  States  and  a  hampered  price  discovery  process.35  On  the  other  hand, 
SBBS might attract additional demand for national sovereign bonds, and thereby add to 
their  liquidity  (this  is  especially  true  for  those  sovereigns  that  are  not  typically  in  the 
radar screen of large global investors—which is also often the case for smaller Member 
States). SBBS portfolios would also support prices, and thus be liquidity-enhancing—as 
bonds included therein could not be sold abruptly in episodes of turbulence.  

35 For this reason, as has been done for example for the ECB's Public Sector Purchase Program, caps could be 
envisaged on the share of outstanding sovereign bonds of individual Member States that can be used for 
SBBS.  

26 

 
                                                      
The impact of option 1.1 on different stakeholders depends on different factors, such as 
the regulatory treatment of the SBBS tranches (see options 2.1 and 2.2) and the market 
size SBBS would ultimately achieve. Annex 3, Table 7 and Table 8 give some overview 
of  expected  impacts  compared  to  the  benchmark  scenario  (in  particular  for  models  1 
and 2).  For  banks,  other  investors  and  arrangers  the  impact  is  expected  to  be  (very) 
positive  given  the  availability  of  a  new  standardised  and  profitable  product.  For 
supervisors, administrative expenses will depend on  the model chosen for ensuring and 
monitoring  compliance  (see  section  6.4).  They  may  be  larger  if  a  certification  of  each 
issuance  is  required  compared  to  the  self-certification  option.  But  in  any  case  these 
expenses are likely to remain small (since all that would be required would be monitoring 
compliance of the underlying portfolio with the ECB capital key and that the tranching 
levels  are  appropriate)  and  to  be  outweighed  by  the  enhanced  stability  of  the  financial 
system  from  greater  diversification  in  banks'  sovereign  portfolios  and  weakened  bank-
sovereign  nexus.  As  discussed  above,  some  national  sovereign  bond  markets  could  be 
adversely  affected  in  terms  of  residual  floating  stock  of  debt,  but  these  effects  would 
materialise  only  if  SBBS  reach  a  truly  large  scale  and  could  in  any  case  be 
counterbalanced by the increased demand for such bonds.  

Neither option 1.1, nor any of the other options discussed below, is expected to impact 
directly on retail investors, households or SMEs, because they would unlikely be active 
in  SBBS  markets.  At  the  same  time,  these  sectors  would  benefit  indirectly—including 
from enhanced confidence—to the extent that the above-mentioned macroeconomic and 
financial-stability benefits materialise. 

Neither option 1.1, nor any of the  other options discussed below, is expected to have a 
direct social impact, environmental impact or impact on fundamental rights.  

6.2.2.  Option 1.2: All securitisations of euro area sovereign bonds 

Option  1.2  envisages  that  the  legislation  is  made  applicable  to  any  securitisation  of 
sovereign bonds, or at least of those sovereign bonds that are actively traded. After all, 
the  economic  considerations  as  to  why  otherwise  such  securitisations  would  stand  no 
chance of being produced and demanded have a rather general applicability.36 

This  option  would  thus  provide  the  widest  possible  scope  of  applicability  of  the 
legislation,  and  would  also  maximize  the  scope  and  flexibility  for  economic  agents  to 
take  advantage  of  securitisation  techniques  to  better  share  and  allocate  euro-area 
sovereign risk. It may also simplify the necessary market infrastructure, e.g., in terms of 
ascertaining/certifying  eligibility  of  any  candidate  securitisation  for  the  product 
legislation,  thus  minimising  administrative  and  other  costs  (more  on  this  in  section  6.4 
below). 

The disadvantage of Option 1.2 would be that it is unlikely that any given securitisation 
of  sovereign  bonds,  among  the  infinite  possible  varieties,  would  become  prominent  or 
established in the market, and thus gain the role and carry out the functions of a liquid 
benchmark  security.  Yet,  liquidity  is  clearly  an  essential  feature  for  any  security  to  be 

36 At present, EU banks can, for example, apply zero risk weights to their holdings of any and all EU sovereign 

bonds denominated in the sovereign's own currency. 

27 

 
                                                      
appealing  for  investors  to  hold,  in  particular  for  securities  which  are  closely  related  to 
sovereign bonds—the benchmark "safe assets" par excellence for investors (see Annex 2, 
in particular the responses to the public survey on liquidity in section 1, the summary of 
the Industry Workshop in section 2, and the summary of the dedicated DMO workshop 
in  section 3).  Unless  these  new  securitisation  products  acquire  sufficient  liquidity,  it 
would for example be unlikely that banks would hold them in lieu of their current (liquid, 
but often too concentrated) holdings of sovereign bonds.37  

For the same reason, the extent to which this option would generate a product with net 
benefits accruing uniformly across euro-area Member States is unclear. It would depend 
on the products that would actually be launched in the market and on which ones (if any) 
become more commonly used over time. 

The  impact  of  option  1.2  on  the  volume  of  AAA  assets  and  on  the  composition  of 
sovereign  portfolios  on  banks'  balance  sheets  would  greatly  depend  on  the  structure  of 
the products issued and purchased by banks. However the expected lack of liquidity for 
those  products  probably  prevents  their  wide  dispersion,  so  that  the  related  impacts 
(compared to the baseline scenario) are expected to be small. 

The impact of option 1.2 on different stakeholders depends on different factors, such as 
the regulatory treatment of the various tranches (see options 2.1 and 2.2) and the market 
size they would ultimately achieve. Overall, the impact on banks and other investors may 
be positive or neutral, as new products become available, although their attractiveness is 
questionable given their lack of standardisation and ensuing likely lack of liquidity. The 
impact on arrangers is expected to be positive or neutral, depending on the profitability of 
the  product  and  the  market  size.  For  supervisors,  the  impact  crucially  depends  on  the 
market  structure  and  is  difficult  to  predict  ex-ante.  As  regards  the  impact  on  national 
sovereign  bond  markets,  the  impact  depends  mainly  on  the  size/attractiveness  of  these 
new  products.  The  bigger their  market, the  more  they  become  a  competing  product  for 
sovereign  bonds  and  may  affect  sovereign  bond  market  liquidity.  At  the  same  time, 
funding  costs  could  be  positively  affected  though  reduced  bank-sovereign  nexus  risks. 
See Annex 3 (in particular models 3 and 4) for further details.  

6.2.3.  Option  1.3:  A  basket  of  euro-are  sovereign  bonds  (with  weights 

according to the official "SBBS recipe") 

Option 1.3 concerns making the legislation applicable to a specific portfolio of sovereign 
bonds,  i.e.  one  whose  individual  weights  are  in  line  with  the  official  "SBBS  recipe"  as 
presented  in  Box 6  (so  this  portfolio  would  be  the  same  as  that  used  for  SBBS,  but 
without  tranching).  In  what  follows,  such  a  product  will  be  referred  to  as  the  "basket". 
Restricting the applicability of the proposed legislation only to this basket, as opposed to 
any basket, is in the interest of facilitating, through standardisation, the emergence of a 
benchmark liquid asset. 

Functionally,  this  basket  would  be  equivalent  to  a  securitisation  with  a  single  tranche. 
However,  from  a  regulatory  point  of  view  it  is  not  a  securitisation,  as  there  is  no 

37 Therefore providing such a wide range of securities with benchmark treatment in terms of regulatory liquidity 

may well be unwarranted. 

28 

 
                                                      
tranching  element  when  constructing  the  product,  which  is  one  of  the  two  defining 
features  of  securitisation.  The  other  defining  feature  is  the  pooling  of  various  types  of 
contractual debt. This means that it may not suffer from the same regulatory hindrances 
faced by securitisations of sovereign bonds. 

The  actual  treatment  of  a  claim  on  this  basket  in  the  baseline  would  depend  on  the 
specifics of the setup. Such ‘claims’ at present may take different forms (e.g., they could 
be  covered  bonds,  corporate  bonds,  or  units  in  a  Collective  Investment  (so  called 
Collective  Investment  Units  or  CIUs)).  Their  regulatory  treatment,  including  eligibility 
for  an  application  of  the  ‘look  through’  principle  as  far  as  CRR-driven  capital 
requirements, may vary accordingly. 

Even though under the proper setup (i.e. as CIUs) investments in this basket may not face 
unfavourable treatment in terms of capital requirements, they are still likely to face other 
hindrances,  especially  in  terms  of  no  or  incomplete  eligibility  for  liquidity  coverage 
requirements  (LCR).38  Thus an  enabling framework  would need  to  tackle at least these 
constraining factors and could result in a standardisation of these claims (which would all 
be  structured  to  benefit  from  the  regulatory  treatment  granted  by  the  enabling 
framework). 

As for Option 1.1, if the product legislation would apply only to this basket (as opposed 
to  any  conceivable  basket  of  euro  area  sovereign  bonds),  a  sizeable  market  for  this 
particular  instrument  is  more  likely  to  develop,  thanks  to  the  induced  standardisation, 
although  again  by  no  means  certain.  Thus,  also  in  this  case  a  narrower  scope  of 
applicability may be more ’enabling’ than a wider one. 

As  for  SBBS  proper  (option  1.1),  this  basket  is  by  construction  a  product  whose  net 
benefits  would  accrue  to  all  euro-area  Member  States.  Through  it,  Member  States  that 
have a small and relatively illiquid sovereign debt market may be able to tap additional 
demand.  A  well-developed  market  for  such  basket  could  also  favour  a  more  uniform 
repercussion on national funding conditions from exogenous increase (say, from outside 
the  euro  area)  for  euro  area  exposure.  This  would  be  positive  for  Member  States  that 
would otherwise not benefit from this enhanced demand for euro exposure, but it is also 
good  for  the  high-rated  Member  States,  which  until  now  serve  as  "safe  havens"  in  a 
crisis,  leading  to  higher  fluctuations  in  their  government  debt  interest  rates  and  unduly 
low  interest  rates  that  could  lead  to  overheating,  misallocation  of  investment,  and  to 
challenges for some investor classes (e.g., pension funds). 

As  there  is  no  tranching,  this  basket  only  provides  diversification  of  risk,  which  on  its 
own  is  insufficient  to  generate  a  low-risk  asset.  We  estimate  that  this  basket  would 
reduce the amount of domestic bonds held by banks in a range of 3% to 34% compared 
to the baseline scenario, depending on the scenario (limited volume versus steady state) 
analysed (see section 5, Annex 4).  

38 If structured as shares in a CIU, investments in a basket (option 1.3) would, per Article 15 of the LCR 

Delegated Regulation, be eligible under certain conditions to the LCR buffer up to a maximum amount of 
EUR 500 million (the amount is limited as this is a deviation from Basel intended for small credit 
institutions) with a 0% haircut (as the underlying assets are government bonds), provided they respect the 
general and operational requirements to be included in the buffer (amongst which historical liquidity). 

29 

 
                                                      
Although  this  basket  would  exhibit  much  lower  price  volatility  than  individual 
government bonds, its credit risk would be higher than that of many individual sovereign 
bonds. The rating of such basket is not expected to be the highest possible ("AAA" in the 
terminology  of  major  credit  rating  agencies),  with  the  immediate  consequence  that  the 
overall amount of AAA-rated sovereign bonds available in the euro area would sharply 
decrease  in  the  market  (-25%)  if  such  baskets  were  to  reach  a  significant  market  size 
(e.g.,  in  the  envisaged  steady  state  scenario).  In  the  limited  volume  scenario,  the  effect 
would  be  smaller  (-3%)  (see  section 4,  Annex 4).  In  fact,  assets  based  on  this  basket 
would  be  riskier  than  the  current  portfolios  of  most  banks.39  Inducing  greater 
diversification could therefore increase the total exposure of banks to sovereign risk for a 
given volume of sovereign debt holdings. It is estimated that in the steady state scenario 
the  share  of  sovereign  bonds  rated  AAA  on  banks'  balance  sheets  could  decrease  from 
24%  to  19%  for  euro  area  banks  (see  section 4  in  Annex 4).  However,  conversely,  the 
share of rather lower-rated government bonds would also decrease. 

The effects of the development of a market for such a basket instrument on the liquidity 
and  funding  conditions  on  national  sovereign  bond  markets  presents  the  same 
opportunities and challenges as discussed for Option 1.1 above. 

Given the specificities of this basket, the impact of option 1.3 on different stakeholders is 
expected  to  be  neutral  or  unclear  (see  also  Annex 3).  While  there  could  be  a  positive 
effect  for  banks,  other  investors  and  arrangers  given  the  availability  of  a  new 
standardised product, its overall profitability is questionable. As for options 1.1 and 1.2 
the  impact  on  supervisors  crucially  depends  on  the  market  structure  and  is  difficult  to 
predict ex-ante. The effect on DMOs and sovereign bond market liquidity is comparable 
to the one of option 1.1.  

6.2.4.  Impact summary and conclusions 

The  main  considerations  weighing  in  favour  or  against  the  three  options  considered  in 
this subsection are summarised in Table 1 below. 

Overall, while conceptually all securitisations and baskets of sovereign bonds would face 
some kinds of regulatory hurdles, it may be preferable to specifically adapt the regulatory 
framework only for one specific securitisation and one specific basket, e.g. those issued 
against a portfolio respecting the "SBBS recipe" as described in Box 6 (as is the case for 
the SBBS proper). This would enhance the likelihood that a structured product of euro-
area sovereign bonds becomes sufficiently traded so as to gain "benchmark"-type appeal.  

39 See section 2.2 of Volume 1 of the HLTF Report. 

30 

 
                                                      
Table 1: Option 1 (scope of applicability): summary assessment  

6.3.  Extent of ’restored’ regulatory neutrality 

This section assesses whether regulatory neutrality should apply to all tranches or only to 
the  most  senior  one,  i.e.  whether  the  most  favourable  regulatory  treatment  (currently 
applicable to each and every component of the underlying portfolio of sovereign bonds) 
should also apply to the whole SBBS instrument. This issue does not concern the basket 
(option 1.3), as there is only one ‘tranche’, or only one type of security (which is either 
given equal regulatory treatment to EU sovereign bonds or not). 

Consider, for example, the determination of capital requirements associated with banks' 
investments  in  tranches  of  a  securitisation  of  sovereign  bonds.  In  this  case,  complete 
regulatory  neutrality  would  require  setting  a  zero  risk  weight  for  all  tranches. 
Alternatively,  one  could  give  the  zero  risk  weight  only  to  the  senior  tranche40  and 
positive  risk  weights  to  the  sub-senior  tranches,  e.g.  in  proportion  to  their  relative 
(estimated)  risk/volatility.  In  this  case,  regulatory  neutrality  would  remain  incomplete: 
the  regulatory  playing  field  with  euro-area  sovereign  bonds  would  become  level  for 
senior tranche, but not for sub-senior ones.  

Similar  considerations  could  be  made  as  regards  other  key  aspects  of  legislation.  For 
example, one could decide to grant the same regulatory status of sovereign bonds, i.e. full 
eligibility  (with  no  haircuts)  for  level-1  treatment  in  the  determination  of  compliance 

40 Feedback from market participants has confirmed that a zero risk weight is essential for the senior tranche—
which, by virtue of its enhanced safety, is likely to have a very low yield—to be attractive for banks, 
including as an alternative to holding (concentrated) portfolios of sovereign bonds. 

31 

Specific ObjectivesOption 1.1 Only SBBS properOption 1.2. All securitisations of euro area sovereign bondsOption 1.3 A basket of euro-are sovereign bonds with weights in line with ECB capital keyEnsure regulatory playing field between the asset and the underlying government bonds(++) It addresses the identified regulatory issues for the SBBS product.(++) The issues arising when the securitisation framework is applied to securitisations of sovereign bonds are addressed in a comprehensive manner.(+) Gives maximum flexibility to market participants as how to use securitisation techniques to better manage risk associated with fluctuations in perceived creditworthiness of euro area sovereigns(+) It addresses any regulatory issues for the basket.Facilitate liquidity and benchmark quality of the asset(++) the narrow applicability of the product regulation could help ensure that all issuers of these new products pool and tranche euro area sovereign bonds in the same way. This would contribute to the emergence of a standardised product, which could underpin greater liquidity and appeal, including as a "natural" way for non-euro area investors to gain euro-denominated (low) risk exposure.(-) the general applicability of the product regulation would reduce the likelihood that a (finite number of) securitisation product(s) would emerge as "benchmarks". This may limit the extent to which individually any such product would be seen as a liquid asset.     (-) Moreover, many securitisations could combine sovereign bonds with varying credit ratings, without any particular criterion. This would per se lower the "brand" value of the product class.(+) To the extent that the proposed regulation would offer a more favorable treatment to this particular basket, it may incentivise issuers of baskets of government bonds to pool euro-area sovereign bonds in the same way. This would contribute to the emergence of a standardised product. 
 
                                                      
with  liquidity-based  requirements  (such  as  LCR  and  NFSR),  to  all  tranches  of  a 
securitisation of sovereign bonds, or alternatively only to the senior tranche. 

The considerations in favour of the former or the latter approach are discussed next. 

6.3.1.  Option  2.1:  Extend the regulatory treatment  of  euro  area  sovereign 

bonds to all tranches  

Option 2.1 extends the regulatory treatment of euro-area sovereign bonds to all tranches 
of an SBBS, which restores ’full neutrality’.  

Full neutrality would maximize the ’enabling’ effect of the legislation:  

1)  From  the  perspective  of  capital  requirements,  assigning  zero  risk  weights  to  all 
tranches  would,  for  example,  allow  banks  to  hold  any  given  fraction  of  their 
aggregate  portfolio  of  euro-area  sovereign  bonds  in  the  form  of  these  tranches, 
without facing additional capital requirements.  

2)  From  the  perspective  of  liquidity  coverage  requirements,  full  eligibility  for 
LCR/NFSR  purposes  for  all  tranches—would  be  more  ’enabling’  than  any  other 
alternative  regulatory  status  because  it  would  ensure  that  the  development  of  an 
SBBS market does not trigger a (regulatory) liquidity ’squeeze’. To understand why 
this is the case, consider that at present all euro-area sovereign bonds are fully eligible 
to meet the liquidity requirements (they are, in technical terms, level-1 High-Quality 
Liquid Assets, or HQLA). If all tranches of a securitisation are also made eligible for 
level-1 HQLA, then the supply of HQLA would not change regardless of the amount 
of  euro  area  government  bonds  which  are  assembled  into  these  new  securitisations 
(that is, regardless of the volume of these new instruments). 

Regarding the benefits and costs in terms of availability of AAA-rated sovereign bonds 
and composition of sovereign portfolios on banks' balance sheets, the impacts are similar 
to those described in section 6.2 for the SBBS proper (option 1.1) and would depend on 
the scenario. In particular, in the limited volume (respectively, steady state) scenario, the 
volume  of  AAA  sovereign  bonds  in  the  euro  area  would  increase  by  2%  (respectively, 
30%), banks' holdings of own-sovereign bonds would decline by 3% (respectively, 34%), 
and  the  share  of  AAA  bonds  in  banks'  sovereign  portfolios  would  increase  by  24% 
(respectively, 32%) (see Annex 4, sections 4 and 5). 

The impact of option 2.1 on different stakeholders depends on different factors, such as 
the  scope  of  applicability  of  the  proposed  legislation  (see  options  1.1  and  1.2)  and  the 
market size SBBS would ultimately achieve. Overall, the positive impact on banks, other 
investors  and  arrangers  given  the  minimised  regulatory  charges  may  be  greater  if 
standardisation  of  the  product  was  guaranteed.  As  for  the  options  discussed  above,  the 
impact on supervisors crucially depends on the market structure that develops. As regards 
the impact on DMOs, the impact depends mainly on the size/attractiveness of SBBS as 
well  as  the  structure  of  the  national  sovereign  bond  market.  Some  national  sovereign 
bonds may be affected more than others and the bigger the size of the SBBS market, the 
larger the possible implications for national sovereign bonds. See Annex 3 (in particular 
models 1 and 3) for further details. 

32 

 
6.3.2.  Option  2.2:  Extend the regulatory treatment  of  euro area  sovereign 

bonds only to senior tranches  

Option  2.2  extends  the  regulatory  treatment  of  euro-area  sovereign  bonds  only  to  the 
senior tranche of a securitisation.  

In this case the proposed legislation would be less ’enabling’ and would (by design) level 
the regulatory playing field only up to a point, i.e. only for the senior tranches. 

Under  this  scenario, any  switch  by  banks  from  direct  holdings  of  sovereign  bonds  to 
tranches  of  securitisations  of  sovereign  bonds  would  result  either  in  increased  capital 
requirements,  or  in  banks  having  to  sell  off  the  part  of  their  sovereign  exposure 
equivalent to the sub-senior tranches to keep their capital requirement unchanged. Either 
way, the perceived risks faced by banks would have declined, or countered with greater 
loss absorption capacity (see also Annex 3 for estimates of the impact on banks). This in 
itself would be positive for financial stability considerations.  

As  regards  government  funding  costs,  the  effects  of  incomplete  regulatory  neutrality 
would depends on banks' reaction (in particular, on the extent to which banks switch their 
current sovereign bond holdings into these new products), on the elasticity of supply of 
bank  (equity)  capital,  and  on  the  elasticity  of  the  demand  by  other  investors  for  any 
sovereign  risk  divested  by  banks.  For  example,  the  impact  on  funding  costs  would  be 
reduced,  and  in  the  limit  disappear,  if  other  investors  that  are  not  subject  to  capital 
requirements would readily purchase sub-senior tranches sold by banks. Member States 
with higher debt would be more affected by any increase in their funding costs. 

Similarly, if junior tranches were not made fully eligible for HQLA status when it comes 
to  compliance  with  LCR/NFSR  liquidity  requirements,  then  the  greater  the  amount  of 
such  securitisations  which  is  assembled,  the  larger  the  effective  reduction  of 
HQLA-eligible  securities  available  to  market  participants,41  which  may  result  in 
increased price for residual HQLA securities (i.e., a reduction in interest rates) and/or in 
pressures for banks to increase the liquidity of their other assets (e.g., scaling down their 
maturity transformation activities).  

Regarding the benefits and costs in terms of availability of AAA-rated sovereign bonds 
and composition of sovereign portfolios on banks' balance sheets, the impacts are similar 
to those describes for option 2.1, except than the share of AAA bonds in banks' sovereign 
portfolios would reach 33% under the most optimistic scenario (see Annex 4, sections 4 
and 5). 

As for option 2.2, the impact of option 2.1 on different stakeholders depends on different 
factors, such as the scope of applicability of the proposed legislation (see options 1.1 and 
1.2)  and  the  market  size  SBBS  would  ultimately  achieve  (see  Annex 3).  As  indicated 
above,  a  more  risk-sensitive  treatment  of  the  non-senior  tranches  would  contribute  to 
making  the  overall  financial  system  more  stable.  Thus  the  impact  on  supervisors  is 

41 Of note, and in contrast to what happens for example with the ECB's purchase programs, sovereign bonds 

underpinning a securitisation would not be envisaged to be lent out for liquidity/collateral purposes—they 
would be effectively withdrawn from the market as far as the total supply of HQLA is concerned. 

33 

 
                                                      
expected to be positive. The impact on DMOs/sovereign bond market liquidity is unclear 
depending  on  different  variables  but  is  overall  expected  to  be  limited  (see  Annex 4, 
section 3).  

6.3.3.  Impact summary and conclusions 

The  considerations  militating  in  favour  of  full  neutrality  for  all  tranches  versus  full 
neutrality only for senior tranches are summarised in Table 2 below. 

On balance, levelling the regulatory playing field for all tranches maximizes the enabling 
nature  of  the  proposed  product  legislation,  and  would  also  minimize  any  capital 
requirement or liquidity squeeze that would result, especially in the presence of a large 
switch  in  banks'  portfolios  out  of  direct  holdings  of  sovereign  bonds  and  into  such 
tranches.  At  the  same  time,  especially  for  sub-senior  tranches,  some  discrepancy  might 
emerge  between,  for  example,  the  granted  HQLA  status  in  terms  of  liquidity 
requirements and the actual market liquidity exhibited by the security. 

Table 2: Option 2 (extent of restored regulatory neutrality)—summary assessment 

6.4.  Ensuring compliance with SBBS criteria and consistency in 

implementation42 

This section describes and assesses three policy options to ensure that any given financial 
instrument complies with the eligibility criteria specified in the product legislation. This 

42 Given the similarities of the issues at stake, this section draws on the impact assessment of the STS regulation 
at: https://ec.europa.eu/info/publications/impact-assessment-accompanying-proposals-securitisation_en 

34 

Specific ObjectivesOption 2.1. Extend the regulatory treatment of euro area sovereign bonds to all tranches Option 2.2. Extend the regulatory treatment of euro area sovereign bonds to senior tranches onlyEnsure regulatory playing field between the asset and the underlying government bonds(+) All the regulatory hindrances to the development of markets for securitisations of sovereign bonds are removed.(+) The enabling nature of the regulation is maximized, since the capacity to offer senior tranches also depends on the demand for sub-senior tranches (the issuers are not supposed to retain any risk associated with their securitisation activities)(+) The senior tranches are given "benckmark quality" regulatory treatment, thus ensuring them a level-playing field with the underlying sovereign bonds. Moreover, the differential treatment may underscore their added safety.(+) More "prudent" treatment of sub-senior tranches--particularly important if the securitised portfolio is not sufficiently diversified or heavily exposed to low-rated sovereigns.(-) Demand for sub-senior tranches may be less forthcoming, especially from banks.Facilitate liquidity and benchmark quality of the asset(+) No capital requirements and liquidity pressures resulting from any switch by banks from direct sovereign bank holdings to tranches of securitisations of sovereign bonds--banks' incentive to switch is maximized.(+) No aggregate "liquidity squeeze" that would result if assembling securitisations of sovereign bonds would reduce HQLA level-1 eligible assets.(-) A mismatch might emerge between the regulatory treatment of a securitisation tranche as liquid and its actual liquidity exhibited in the marketplace--this is especially likely for sub-senior tranches, in particular those issued against non-diversified portfolios.(+) The differential regulatory treatment could underscore the enhanced safety of senior tranches. Especially if a standardised senior tranche emerges in the market, it may more naturally become a benchmark.  
 
                                                      
is a crucial aspect for investors' trust, which is itself particularly important in determining 
the chances of success of a completely novel product. Irrespective of the decision taken 
on the options described in this section, four general principles must apply and contribute 
to the proper implementation of the product legislation. 

(a)  Ensuring  investors'  due  diligence  (investors'  responsibility):  The  compliance 
mechanism is not intended to provide an opinion on the level of risk embedded in the 
securitisation,  nor  any  guarantees  of  payouts.  The  scope  of  the  compliance 
assessment should be strictly limited to criteria establishing the 'foundation approach', 
namely  applying  to  the  structure  of  the  instrument.  Investors  should  continue 
performing  careful  due  diligence  of  any  securitisation  of  sovereign  bonds  before 
investing.  

(b) Responsibility to comply is first on originators. Originators (or arrangers) of SBBS 
instruments  should  bear  primary  responsibility  toward  ensuring  that  their  product 
fulfils  the  criteria.  They  will  have  to  attest  that  the  product  is  meeting  all  SBBS 
criteria. The onus would remain on originators as they are in possession of the most 
complete  information  regarding  the  product  and  are  the  best  placed  to  make  the 
determination on the characteristics of the instruments.43 In addition, if the originator 
is found liable for misleading or false attestation, sanctions on originators would be 
much more effective than sanctions on the securitisation vehicle itself. 

(c) Sanctions should be in place for non-compliance. There is a need for appropriate 
sanctioning measures for participants in the SBBS market to set the right incentives. 
For originators, the measures would refer to normal supervisory sanctioning powers. 
Sanctions  should  be  both  proportionate  and  dissuasive  to  prevent  investors  being 
misled and could range from pecuniary fines to a prohibition against further issuances 
for a pre-determined period of time. There is also a need to consider the implications 
on investors (e.g. what happens if a securitisation is re-qualified as non-qualifying for 
the new regulatory treatment). Investors would, for example, no longer benefit from 
incentives attached to the 'SBBS category'. In this case, a transitional period could be 
foreseen  for  investors,  e.g.  to  prevent  fire-sales.  Specific  sanctions  should  also  be 
applied to any independent third parties involved in the process. 

(d)  Appropriate  public  oversight.  In  the  course  of  their  regular  assessments  of 
prudential  requirements  (e.g.  onsite/off-site  examination  of  solvency  requirements), 
supervisors  will  verify  compliance  with  the  eligibility  criteria.  This  monitoring  is 
important to ensure the accuracy of prudential ratios, since these new products would 
benefit from a specific prudential treatment. Specific monitoring arrangements should 
also  be  defined  for  originators  of  SBBS  instruments—especially  if  they  are  not 
already under supervision, for example by virtue of not being banking entities—and 
for potential third parties. 

6.4.1.  Option 3.1: A compliance mechanism based on self-attestation 

Under  this  option,  the  responsibility  for  determining  compliance  with  SBBS  criteria 
would lie with originator firms, which would be legally liable for attesting that all criteria 

43 This information advantage is however very limited in the case of either SBBS or the basket, since the 

underlying assets—i.e., euro-area government bonds—are well known to all investors, and they are routinely 
traded (so that a relevant price signal is in nearly all circumstances available). 

35 

 
                                                      
were met. They would be required to disclose this attestation in the offer documents after 
an appropriate assessment of each of the criteria. Ex-post oversight would be carried out 
as  in  normal  supervisory  activities.  The  eligibility  of  an  SBBS  securitisation  for  the 
envisaged prudential treatment would therefore still be subject to supervisory checks. 

(a) Effectiveness  

The  attestation  would  establish  legal  liabilities  for  originators,  which  would  create  a 
safeguard  for  investors.  This  approach  would  not  fully  eliminate  investors'  concerns 
about  conflicts  of  interests  by  originators  that  may  affect  the  objectivity  of  their 
attestation. Therefore misleading self-attestation is the main risk of this approach. Yet it 
needs to be kept in mind that, given the specialness of the underlying assets (i.e., euro-
area  government  bonds),  there  is  little  if  any  scope  for  discretion  on  the  part  of  the 
originator in how to assemble the product, especially when the "recipe" is basically given 
(as is the case under Options 1.1 and 1.3). The risk can be further lowered by ensuring 
that false self-attestation would have serious consequences for the originators if unveiled 
for example in the course of an inspection by supervisors.  

These supervisory checks, which could be carried out on a risk basis, would provide the 
overarching guarantee of the correct functioning of the system 

Nevertheless,  incentives  would  remain  for  investors  to  carry  out  due  diligence  (again, 
this  is  expected  to  be  not  too  involved,  thanks  to  the  nature  of  assets  underlying  these 
new  structures  and  the  (simple)  requirements  to  qualify  for  the  envisaged  regulatory 
treatment.  Needless  to  say,  due  diligence  on  the  part  of  investors  is  key  for  a  safe  and 
sustainable market.  

This approach does not limit in any way the recourse to validation by third parties of a 
deal's  SBBS  status.  If  the  latter  will  provide  value  added  to  investors  and  originators, 
they will require it and a market will arise. It should be noted that, given the specialness 
of  the  new  products,  the  role  of  a  third-party  validator  would  likely  be  quite  limited, 
possibly to merely confirming that the structure does contain the stated sovereign bonds 
in the stated quantities (and thus confirm, quite trivially, whether these align or not with 
the ECB capital  key). Differently from other  securitisations, in  other words, third-party 
validators would not need to offer opinions nor due extensive diligence on the underlying 
assets, as these are well-known.  

(b) Efficiency and impact for stakeholders 

This option would increase originators' liability in case of wrongdoing, while maintaining 
investors'  due  diligence  incentives.  Since  supervisors  would  only  be  involved  ex-post 
when  reviewing  prudential  requirements,  it  could  be  argued  that  this  setup  would 
minimize expectations on the part of investors of "bailout" by public entities if something 
goes wrong (compared to a setup where investors buy the new product on the basis of a 
certification by a public entity—see option 3.3 in section 6.4.3). In addition, third parties 
could  anyhow  be  involved  in  the  compliance  mechanism  if  the  markets  value  such  an 
involvement and are therefore willing to pay for it. This option will therefore not limit in 
any way the development of third party validation schemes. If these will provide value 
added to investors, these should require it and issuers should adapt. 

36 

 
This approach would have limited novel financial implications for public budgets, since 
supervisors  would  check  compliance  ex-post  in  the  course  of  their  routine  supervisory 
activities.  Originators  would  have  to  support  the  self-attestation  costs,  which  should 
however  be  quite  small  (the  extent  to  which  these  are  translated  to  investors  would 
depend  on  the  competitiveness  of  the  market).  In  the  absence  of  an  ex-ante  public 
intervention,  this  approach  would  not  eliminate  regulatory  risks  for  investors  as 
self-attested SBBS instruments could be re-qualified at a later stage. 

6.4.2.  Option 3.2: Option 3.1, with the involvement of third-parties 

Similar to option 3.1, option 3.2 would rely on self-attestation by originators. It would, 
however,  be  complemented  by  the  mandatory  involvement  of  a  third  party,  for 
certification  and/or  for  management  purposes.  As  investors  may  have  concerns  with 
fraudulent declarations by originators, they might view self-attestation as not sufficient to 
build  the  critical  amount  of  trust  for  the  SBBS  market  to  take  off.  A  control  system 
relying on independent third parties could thus be established to prevent the issuance of 
non-compliant SBBS instruments. 

This option could build on EU procedures in place to establish labelling in other areas.44 
'Control bodies' could be designated to perform specific checks to assess compliance with 
the  eligibility  criteria.  These  bodies  would  in  turn  respect  requirements  defining  the 
nature,  frequency  and  conditions  of  their  controls.  A  specific  oversight  or  licensing 
regime would have to be developed in order to authorise and monitor these independent 
bodies. 

(a) Effectiveness  

Under option 3.2, the self-attestation would be complemented by an independent review 
of  compliance  with  the  eligibility  criteria.  This  approach  would  help  address  any 
concerns  related  to  the  truthfulness  of  originators'  prospectuses,  providing  additional 
confidence to investors. Appropriate safeguards would be needed to prevent and address 
potential conflicts of interests with originators, especially if third parties were to rely on 
"issuer-pays" models. 

If properly performed, third-party reviews would give additional assurance to investors. 
The drawback is that the third-party review may induce lower scrutiny and due diligence 
by  investors.  It  should  be  noted  that,  in  the  case  of  tranched  products,  to  some  extent 
relieving investors of the need to do due diligence could be considered as part and parcel 
of the creation of a "liquid low-risk asset", as arguably one feature of such an asset is that 
it  can  and  will  be  traded  with  "no  need  to  ask  questions".  To  the  extent  however  that 
sub-senior  tranches  are  not  standardised,  reducing  incentives  for  due  diligence  by 
investors can be suboptimal. 

(b) Efficiency and impact for stakeholders 

This option would rely on private sector entities to perform independent assessments of 
SBBS. Several entities may enter into this market and competition could limit the costs 

44 For instance for organic products (i.e. Council Regulation n°834/2007) 

37 

 
                                                      
for  issuers.  Involving  private  entities  would  make  the  mechanism  more  flexible  and 
scalable  to  market  activities.  However,  it  would  also  imply  additional  costs,  though  as 
discussed  these  could  be  expected  to  be  small  since  the  third-party  validator/reviewer 
merely needs to confirm that the content of the structure is exactly as advertised in the 
prospectus. 

This approach would have similarities with other EU policy, in particular the procedures 
for  EU  labelling.  Public  oversight  of  the  independent  entities  could  also  build  on  the 
approach  developed  for  the  registration  and  oversight  of  credit  rating  agencies.  It  is 
important  to  note  that  this  approach  may  present  similar  issues  and  risks  causing 
'overreliance' on third parties, as has arguably been the case with credit rating agencies. 
Originators  and  investors  may  favour  this  option,  if  they  would  share  part  of  the 
liabilities with third parties. Their increased confidence notwithstanding, investors would 
not  get  full  regulatory  certainty,  as  the  final  prudential  determination  of  compliance 
would remain with the supervisors. 

6.4.3.  Option  3.3:  Option  3.1  with  ex-ante  supervisory  checks  on  each 

issuance 

Similar  to  option  3.1,  option  3.3  would  rely  on  the  self-attestation  of  originators, 
complemented  by  ex-ante  checks  by  supervisory  authorities.  This  option  would  offer  a 
higher  degree  of  credibility  due  to  the  specific  status  of  supervisory  authorities. 
Furthermore,  prudential  authorities  benefit  from  a  wider  overview  of  market  practices 
and  are  less  likely  to  be  subjected  to  issues  related  to  information  asymmetries. 
Moreover, with no ’issuer-pays’ model, no conflicts of interest should arise. 

This approval mechanism would be developed for each issuance of the new instrument. 
This would ensure that each individual issuance meets the eligibility criteria. Compared 
to the previous options it would, however, imply higher compliance costs for securities 
regulators,  but  again  should  not  be  too  expensive  because  of  the  simple  nature  of  the 
instrument  and  its  underlying assets.  Checking  the  legal  setup, for example in  terms of 
the correct specification of the waterfall of payments in case of an SBBS proper, may be 
more  costly.  But  it  is  likely  that  a  standard  setup  would  emerge,  reducing  such 
monitoring costs over time. 

Alternatively,  an  'issuer-based  approach'  could  be  developed.  This  would  mainly  focus 
on  processes  implemented  by  originators  to  ensure  compliance  with  eligibility  criteria. 
This would result in a kind of license granted by the authorities. The initial licensing or 
approval  would  be  comprehensive  and  detailed,  and  thus  somewhat  more  resource 
intensive, but it would reduce the subsequent compliance costs, as originators would not 
be required to  renew approval  for every new transaction. This  setup would  thus  favour 
large originators, which could amortise the licensing costs over larger volumes. 

(a) Effectiveness 

Instead  of  relying  on  independent  third  parties,  supervisors  would  directly  assess  the 
compliance with eligibility requirements. This approach would be the most powerful to 
ensure investors' confidence. This option would contribute to a sustainable development 
of  these  new  markets,  while  reducing  the  risks  of  confidence  crises  and  attendant 
spillovers, which in the limit could jeopardise financial stability.  

38 

 
However,  reliance  on  supervisors  would  reduce  substantially  investors'  incentives  to 
perform thorough due diligence. It could also generate expectations of "bailouts", should 
the products experience difficulties. Also, this would reduce the responsibility of issuers, 
as supervisory approval would be necessary.  

(b) Efficiency and impact for stakeholders 

This  option  would  be  the  most  efficient  in  terms  of  ensuring  the  credibility  of  the new 
products.  However,  it  would  require  greater  public  resources  as  supervisory  authorities 
would  have  to  take  on  new  tasks.  These  costs  would,  of  course,  be  minimized  if  the 
"SBBS  proper"  model  is  chosen,  whereby  detecting  non-compliance  with  the  given 
"recipe" (i.e., portfolio weights and tranching levels) would be relatively straightforward. 

While  investors  and  originators  may  appreciate  the  legal  certainty  associated  with  a 
supervisory  review,  supervisory  authorities  may  face  additional  liabilities  and  concerns 
about moral hazard issues.  

6.4.4.  Impact summary and conclusion  

Error! Reference source not found. summarises the relevant considerations.  

Table 3: Option 3 (Compliance mechanism)—summary assessment 

Option/ 
Specific 
objectives 

Option 3.1: 
Compliance mechanism 
based on self-attestation 
by originators 

Option 3.2:  
Option 3.1 with the 
involvement of third-
parties 

Effectiveness  (=) Investor confidence 

would depend on 
reputation of issuer and 
potential sanctions 
(++) Reduced "moral 
hazard" risks as 
incentives for due 
diligence remain high 

Efficiency 

(+) Limited costs for 
public finance and public 
authorities resources. 

(+) Investor confidence 
would be increased as 
independent assessment of 
eligibility criteria will be 
available 
(-) Increased "moral 
hazard" risks as incentives 
to investors' due diligence 
are weaker 
(+) Higher flexibility and 
scalability of the process 
(-) Additional costs for 
originators and need to 
introduce public oversight 
for 3rd parties 

Option 3.3:  
Option 3.1 
complemented by ex-
ante supervisory checks 
on each issuance 
(++) Strong and positive 
effects on investor 
confidence 
(--) Increased "moral 
hazard" risks as investors 
might come to expect 
public backing for the 
product. 

(-) Public authorities 
would need more 
resources to take up new 
tasks 

Impact on 
stakeholders 

(+) Better alignment of 
incentives between 
originators and investors 
(liability for potential 
risks) 
(-) Investors would not 
benefit from external 
support in assessing 
compliance with 
eligibility criteria. 

(+) Would provide 
additional confidence to 
investors in assessing 
compliance with eligibility 
criteria 
(-) Even with 3rd parties 
involved, final prudential 
decisions would remain a 
competence for 
supervisors 

(=) Greater legal certainty 
for investors-originators, 
but concerns on the 
scalability and timeliness 
of the mechanism 
(-) Potential reputation 
risks for public authorities 

39 

 
Although  the  extent  of  asymmetric  information  between  originators  on  one  side  and 
investors/supervisors on the other is even less than in the case of the STS securitisation, 
Option 3.1, i.e. attestation by originators, comes across also here, like in the case of the 
STS  securitisations,  as  the  preferred  setup  to  ensure  compliance  with  the  eligibility 
criteria  of  the  new  products.  This  setup  would  ensure  that  originators  remain  liable  for 
issuing  instruments  meeting  eligibility  criteria  and  should  incentivise  investors  to 
perform appropriate due diligence, while minimizing novel costs on supervisors (as well 
as moral hazard concerns). Issuers should face appropriate sanctions if they make wrong 
declarations. This approach could be combined with option 3.2, but on a non-mandatory 
basis. Originators would still have the possibility to ask for a review by an independent 
third party if they consider that this would provide added value.  

7.  HOW DO THE OPTIONS COMPARE?  

The options described in the previous section can be combined to form "models" which 
in turn can inform the proposed product legislation.  

Figure 5: The decision tree  

40 

 
 
In particular, Figure 5 shows how combining the options considered in terms of scope of 
applicability  of  the  legislation  (section  6.2)  and  extent  of  restored  regulatory  neutrality 
(section 6.3) generates five distinct models, which will be compared in this section. Note 
that the arguments underpinning the superiority of the self-attestation model (Option 3.1) 
as  setup  to  ensure  compliance  with  the  proposed  legislation  are  largely  independent  of 
the  options  considered  in  sections  6.2  and  6.3.  Therefore  Option  3.1  would  be  used 
regardless of the specific model chosen, and it is not discussed further in what follow.  

The comparison among the five models with the baseline (no regulatory intervention) is 
summarised in Table 4. The first two rows of the Table capture the extent to which each 
model  advances  the  achievement  of  the  specific  objectives  set  out  for  the  legislative 
intervention, namely securing "regulatory neutrality" for the new product vis-à-vis euro 
area sovereign bonds and facilitating their liquidity (de jure and de facto) and scope for 
becoming  "benchmark-like"  instruments.  The  other  rows  assess  the  various  models 
against other desirable objectives. 

Table 4: Assessment 

The  different  models  perform  differently  against  the  various  criteria.  In  particular, 
models  1,  2  and  5 (in which  the  legislation  would  apply  to  products  with  pre-specified 

41 

Model 1Model 2Model 3Model 4Model 5Only SBBS proper;Treat all tranches as euro area sovereign bondsOnly SBBS proper;Treat only Senior  tranches as euro area sovereign bondsAll securitisations;Treat all tranches as euro area sovereign bondsAll securitisations;Treat only Senior  tranches as euro area sovereign bondsProper SBBS basket;Treat basket as euro area sovereign bondsRegulatory NeutralityyespartialyespartialyesLiquidity/benchmark qualityyesyesnonopartialMinimizes capital requirements?yes for SBBSno, sub-senior tranches would still command high risk weights for SA banksyesno, sub-senior tranches would still command high risk weights for SA banksyesAssembling  of the product does not result in reduction of HQLA assetsyesnoyesnoyesDoes not impair liquidity of national sovereign bond marketsAmbiguous (*). Effects likely to be small if market size is limitedAmbiguous (*). Effects likely to be small if market size is limitedEffects (if any) likely to be small.Effects (if any) likely to be small.Ambiguous (*). Effects likely to be small if market size is limitedHelps expand amount of low-risk assetsyes, senior SBBS is          low-riskyes, senior SBBS is          low-riskuncertainuncertainnoFacilitates banks' diversificationyesyesuncertain, it depends on what product is developeduncertain, it depends on what product is developedyesFacilitates cross-border financial integrationyes especially thanks to the standardization yes especially thanks to the standardization yesyesyesFacilitates bank   de-riskingyesyes, and more than Model 1, since there would be a built-in incentive to offload junior tranchesuncertain, it depends on what product is developeduncertain, it depends on what product is developed. But more than Model 3, since there would be a built-in incentive to offload junior tranchesuncertain, as it depends on the product. Less than Model 2, since the asset would be diversified, but without the protection of the junior trancheFacilitates smooth absorption of asymmetric capital flowsyesyesuncertain, it depends on what product is developeduncertain, it depends on what product is developedyesEffectivenessOther positive effects 
 
structures)  would  fare  better  than  models  3  and  4  (in  which  the  proposed  product 
legislation  would  apply  to  any  and  all  securitisations  of  euro-area  sovereign  bonds)  in 
developing  a  standardised  product,  which  –  as  also  underlined  by  stakeholders  in  the 
ESRB public consultation (see Annex 2, section 1) and industry workshop (see Annex 2, 
section 2) – is key for the liquidity and attractiveness of the new product. 

Models 1 and 2, allow the creation of a new euro-denominated, euro area representative 
low-risk  synthetic  asset  (the  senior  tranche),  which  could  over  time  compete  in  the 
international  financial  markets  with  such  benchmarks  as  bonds  from  the  US  or  Japan 
(Models 3 and 4, which lack standardisation, would not).  

Model 5,  despite  featuring  standardisation,  does  not  quite  achieve  that,  because  it  does 
not feature tranching (and thus added "protection" to at least the senior tranche). Indeed, 
Model 5 could over time even result in an aggregate reduction of AAA-rated assets (see 
Annex 4.4). It might also not deliver on de-risking banks' bond portfolios as assets based 
on  this  basket  would  be  riskier  than  the  current  portfolios  of  most  banks,  thus  banks 
would have no incentive to swap into this asset. On the other hand however, it offers the 
very  positive  feature  of  avoiding  the  complexities  associated  with  securitisations45 
(which Models 3 and 4 would not).  

So, the choice between Models 1 and 2, on one hand, and Model 3 on the other, comes 
down  to  the  relative  importance  attached  to  creating  a  synthetic  low-risk  asset  versus 
keeping things simple.  

The choice between Models 1 and 2 comes down to a trade-off between maximizing the 
"enabling"  effect  of  the  proposed  regulation  (Model  1)  versus  maximizing  its  financial 
stability benefits (Model 2).  

By providing the most favourable regulatory treatment to all tranches, thus for example 
ensuring that the development of SBBS markets does not adversely affect banks' access 
to  high-quality  liquid  assets,  Model 1  is  by  definition  more  "enabling"  than  Model 2.46 
Model 2, however, could give greater benefits in terms of overall risk reduction if it led 
to a transfer of riskier sovereign exposures from banks to other investors which are better 
equipped  to  handle  them  and  whose  financial difficulties  would  not  be  expected  to  put 
any  direct  pressure  on  public  finances  of  individual  Member  States.47  Of  course,  a 
necessary  condition  for  this  "good  equilibrium"  to  emerge  would  be  that  SBBS  would 
prove  economically  viable  even  in  the  presence  of  remaining  regulatory  hindrances  of 
various types on sub-senior tranches.  

45 E.g., properly enforcing the waterfall of payments in the case some underlying bonds experience debt service 

difficulties. 

46 Recall that, for senior tranches to be "produced", issuers/arrangers have to be confident that sufficient demand 

also comes forth for sub-senior tranches. 

47 It may be worthwhile noting that setting out incentives whereby banks would not want to hold sub-senior 

SBBS tranches (as would be the case in Model 2) does not mean that banks' total exposure to EU sovereign 
risk must necessarily decline, as banks could decide to switch their entire current holdings of EU sovereign 
bonds into senior SBBS. Again, as discussed in Section 6.3.2, the net effects on the funding costs of euro-
area sovereigns would depend on several factors, including the elasticity of demand for sub-senior SBSB by 
investors not subject to CRR requirements (e.g., hedge funds). 

42 

 
                                                      
8.  PREFERRED OPTION 

8.1. 

Preferred model 

Our analysis shows that, given the importance of standardisation for the development of 
a benchmark-type asset, Models 3 and 4 are likely to be inferior.  

As far as the remaining models are concerned, however, each has different strengths in 
addressing different  issues.  No  clear  conclusions  thus  emerge  from  the  analysis  as  to  a 
single  best  model  (understood  as  a  single  collection  of  best  options)  in  terms  of  both 
effectiveness  and  efficiency.  Political  considerations  will  be  required,  therefore,  to 
prioritise  the  choices,  based  on  the  impacts  and  trade-offs  presented  in  the  preceding 
sections.  

Regarding  the  regulatory  treatment  of  the  different  tranches  of  the  product,  Model 1 
would restore full regulatory neutrality, which  would maximize the ’enabling’ effect of 
the  legislation.  Model 2  would  be  less  ’enabling’  than  model 1  and  would  (by  design) 
level the regulatory playing field only up to a point, i.e. only for the senior tranches. It 
might, however, lead to greater de-risking by banks, and thus greater financial stability 
benefits,  if—despite  the  higher  charges  on  sub-senior  tranches—SBBS  nevertheless 
proved  viable.  Model 5  would  be  enabling  to  the  extent  only  that  it  is  de  facto  the 
regulatory treatment that is currently hindering the instrument's natural emergence.  

Regarding  the  choice  of  the  compliance  mechanism,  as  with  the  STS  securitisation,  a 
model  based  on  attestation  by  originators,  possibly  complemented  by  third  party 
certification on a voluntary basis (option 3.1 in section 6.4), is the preferred option as it 
would  ensure  that  originators  remain  liable  for  issuing  instruments  meeting  eligibility 
criteria and incentivise investors to perform appropriate due diligence, while minimizing 
novel costs on supervisors (as well as moral hazard concerns).  

8.2.  REFIT (simplification and improved efficiency)  

This initiative introduces new rules for a new financial instrument, namely SBBS. This 
initiative  simplifies  the  regulatory  treatment  of  this  instrument  and  should  enable  the 
development  of  a  new  market.  Simplification  concerns  several  aspects,  including  the 
restrictions on investing in these instruments by some financial institutions.  

9.  HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?  

In  terms  of  securing  the  specific  objectives  (i.e.,  eliminate  regulatory  hindrances  and 
contribute to the liquidity of the new products, including by granting them "benchmark" 
regulatory  treatment),  if  either  model  1  or  3  is  chosen,  all  that  can  be  achieved  by 
legislation is indeed achieved once the proposed legislation is approved and enters into 
force  (because  only  a  standardised  product  would  then  be  made  eligible,  capital 
requirements  would  be  effectively  eliminated,  and  the  best  possible  treatment  as  far  as 
liquidity  coverage  requirements  would  be  granted).  For  model  2,  which  would  involve 
some  calibration  (e.g.,  for  the  risk  weights  of  sub-senior  tranches  for  pillar-1  capital 
requirement  purposes),  regular  monitoring  after  sufficient  data  has  become  available 
(say, in three or five years) would be helpful to ascertain whether the calibration chosen 
remains appropriate. 

43 

 
In terms of the general objective to enable markets for these new products, (i.e., SBBS or 
baskets, depending on the model ultimately chosen) the impact of the legislation will be 
assessed  by  monitoring  the  extent  to  which  these  new  products  will  be  actually 
assembled and traded, and—in turn—how much they contribute to the benefits measured 
by  the  benchmarks  presented  in  section  6.1.2  (e.g.,  expanding  the  amount  of  low-risk 
assets, reducing the "home bias" in banks' sovereign bond portfolios,  etc.). Information 
on  the  amount  of  SBBS  assembled  and  traded  is  expected  to  be  readily  available, 
including  because  of  the  envisaged  notification  and  registration  requirements  for  each 
issuance.  As  regards  the  other  benchmarks,  data  on  the  aggregate  amount  of 
euro-denominated low-risk (e.g., AAA-rated) instruments, or on the ratio between banks' 
holdings  of  bonds  issued  by  their  own  government  relative  to  their  total  holdings  of 
sovereign  bonds,  or  on  the  relative  share  of  highly-rated  sovereign  bonds  on  banks' 
balance  sheets  are  also  readily  available.  The  extent  of  their  impact  on  the  liquidity  of 
national  sovereign  bond  markets  will  also  be  assessed,  using  traditional  measures  of 
liquidity (e.g., bid-ask  spread, volume traded,  etc.).  It is  proposed  that the Commission 
produces  a  report  five  years  after  the  entry  into  force  of  this  regulation,  and  at  5-yer 
intervals thereafter. 

When interpreting the results of the afore-mentioned monitoring activities, it needs to be 
kept in mind, however, that both the development of this new market and the evolution of 
most if not all of the above-mentioned benchmarks depend on several other factors which 
are independent of, or may be only tenuously linked to, the regulatory framework. This is 
likely to make it difficult to disentangle the effects of the proposed legislation per se. In 
particular,  for  example,  the  supply  of  new  products  is  also  likely  to  depend  on  such 
factors as the legal costs (i.e., lawyers' fees) of setting up the issuing vehicle, the ease of 
procuring bonds of sufficiently uniform terms on either the secondary or primary market, 
the costs of servicing the structure, etc. Similarly, the demand of SBBS will depend on 
the  overall  interest  rate  environment,  the  risk  appetite,  and  the  demand  from  various 
investor types for the different tranches, etc. Market developments may also well be non-
linear, as it is in the nature of the envisaged product that it benefits from returns to scale 
from size and network externalities. Thus, for example, if the product appears to attract 
sufficient  investor  interest,  it  is  possible  that  debt  managers  may  decide  to  organise 
dedicated  auctions  for  the  production  of  SBBS,  with  standardised  bonds  of  varying 
maturities. This would, in turn, reduce production costs and could accelerate the growth 
of the market.  

44 

 
 
 
LIST OF REFERENCES 

Altavilla, C., Pagano, M., & Simonelli, S. (2016), "Bank exposures and sovereign stress 
transmission", Working Paper 11, European Systemic Risk Board. 

Banca d'Italia (2014), "The negative loops between banks and sovereigns", occasional 
papers, number 213, by Paolo Angelini, Giuseppe Grande and Fabio Panetta, 
http://www.bancaditalia.it/pubblicazioni/qef/2014-0213/QEF_213.pdf.  

Basel Committee on Banking Supervision (2017), "The regulatory treatment of sovereign 
exposures", Discussion Paper (December 2017), https://www.bis.org/bcbs/publ/d425.htm 

Bessler, W., A. Leonhardt and D. Wolf (2016). “Analyzing hedging strategies for fixed 
income portfolios: A Bayesian approach for model selection.” International Review of 
Financial Analysis, Forthcoming. 

Brunnermeier, M.K., L. Garicano, P. Lane, M. Pagano, R. Reis, T. Santos, D. Thesmar, S. 
Van Nieuwerburgh, and D. Vayanos (2016a). “The sovereign-bank diabolic loop and 
ESBies.” American Economic Review P&P, 106(5): 508-512. 

Brunnermeier, M., S. Langfield, M. Pagano, R. Reis, S. Van Nieuwerburgh and D. Vayanos 
(2016b), ESBies: Safety in the tranches, No 21, ESRB Working Paper Series, European 
Systemic Risk Board, https://www.esrb.europa.eu/pub/pdf/wp/esrbwp21.en.pdf  

De Marco and Macchiavelli (2016), "The political origin of home bias: the case of Europe", 
Finance and Economics Discussion Series, Federal Reserve Board, 2016-060. 

Erce. A (2015), "Bank and sovereign risk feedback loops", Working Paper Series 1, ESM, 
https://www.esm.europa.eu/sites/default/files/esmwp1-09-2015.pdf. 

European Commission (2017), "Reflection paper on the deepening of the economic and 
monetary union", https://ec.europa.eu/commission/publications/reflection-paper-deepening-
economic-and-monetary-union_en.  

European Systemic Risk Board High-Level Task Force on Safe Assets (2018a), "Sovereign 
bond-backed securities: A feasibility study", Volume I, January 2018, 
https://www.esrb.europa.eu/pub/task_force_safe_assets/shared/pdf/esrb.report290118_sbbs_
volume_I_mainfindings.en.pdf. 

European Systemic Risk Board High-Level Task Force on Safe Assets (2018b), "Sovereign 
bond-backed securities: A feasibility study", Volume II, January 2018, 
https://www.esrb.europa.eu/pub/task_force_safe_assets/shared/pdf/esrb.report290118_sbbs_
volume_II_technicalanalysis.en.pdf. 

Gao, P., P. Schultz and Z. Song (2017). “Liquidity in a market for unique assets: specified 
pool and to-be-announced trading in the mortgage-backed securities market.” Journal of 
Finance, 72(3): 1119-1170. 

Guembel and Sussman (2009), "Sovereign Debt without Default Penalties", Review of 
Economic Studies, 76, 1297–1320. 

Horváth, B L, H Huizinga, and V Ioannidou (2015), "Determinants and valuation effects of 
the home bias in European banks' sovereign debt portfolios", CEPR Discussion Paper 10661. 

Juncker, J.-C. (2017a), "State of the Union Address 2017", 13 September 2017, 
SPEECH/17/3165, http://europa.eu/rapid/press-release_SPEECH-17-3165_en.htm  

45 

 
Juncker, J.-C. (2017b), "Letter of intent to President Antonio Tajani and to Prime Minister 
Jüri Ratas", 13 September 2017, https://ec.europa.eu/commission/sites/beta-
political/files/letter-of-intent-2017_en.pdf  

Persaud (2017), speech at the Nex Conference on the Future of European Government 
Bonds, Brussels, 7 November 2017: "Local assets are a good hedge against liabilities linked 
to the government and local inflation. It is appropriate that risk-takers take risks with which 
they are most familiar". 

Schlepper, K., Hofer, H., Riordan, R. and Schrimpf, A. (2017), “Scarcity effects of QE: A 
transaction-level analysis in the Bund market.” Deutsche Bundesbank Discussion Paper no. 
06/2017. 

Schneider, M., Lillo, F. and Pelizzon, L. (2016). “How has sovereign bond market liquidity 
changed? An illiquidity spillover analysis.” SAFE Working Paper no. 151. 

Schönbucher, P. J. (2003). “Credit Derivatives Pricing Models: Models, Pricing and 
Implementation.” London: Wiley. 

46 

 
 
ANNEX 1 

PROCEDURAL INFORMATION  

1.  LEAD DG, DeCIDE PLANNING/CWP REFERENCES 

Directorate-General  for  Financial  Stability,  Financial  Services  and  Capital  Markets 
Union (DG FISMA). 

DECIDE FICHE PLAN/2017/1678 

2.  ORGANISATION AND TIMING 

Adoption expected in May 2018 

3.  CONSULTATION OF THE RSB 

An upstream meeting was held on 20 October 2017. 

The draft report will be sent to the Regulatory Scrutiny Board (RSB) on 19 January 2018. 

The RSB meeting took place on 14 February 2018. 

The RSB delivered a positive opinion with reservations on 16 February 2018. 

4.  EVIDENCE, SOURCES AND QUALITY 

This impact assessment is based primarily on the analysis done by the ESRB HLTF. The 
report  of  the  ESRB  HLTF  was  published  on  29/01/2018.  The  European  Commission 
(DG FISMA and DG ECFIN) contributed intensively to the overall analysis of the HLTF 
and  its  report.  The  assessment  is  based  on  analytical  analysis,  a  public  stakeholder 
consultation, a stakeholder workshop and bilateral meetings with stakeholders.  

In particular these include the following: 

  A  dedicated 

industry  workshop  was  held 

in  Paris 

in  November  2016 

(https://www.esrb.europa.eu/news/schedule/2016/html/20161209_esrb_industry_
workshop.en.html).  

  A public survey/questionnaire was run on the ESRB website at the end of 2016/ 
early 2017 (https://www.esrb.europa.eu/mppa/surveys/html/ispcsbbs.en.html).  
  A  workshop  to  gather  the  views  of  the  Public  Debt  Managers  (DMOs)  was 

conducted in Dublin on 20 October 2017. 

  Statistics and data from various sources, including ECB, EBA, Eurostat.  
  Academic (economic) literature (see List of References of the ESRB HLTF report 

volume I and II, as well as of this document). 

For  a  detailed  description  of  the  methodological  approach,  analytical  methods,  and 
limitations of the evidence underpinning this impact assessment, see Annex 4. 

47 

 
 
 
 
ANNEX 2 

STAKEHOLDER CONSULTATION  

As  part  of  its  feasibility  assessment  of  SBBS,  the  HLTF  has  conducted  a  public 
consultation in late 2016 on the ESRB website, and has sought input and feedback from 
the industry and from Public Debt Managers (DMOs), including through two dedicated 
workshops, respectively an open one in November 2016 in Paris and a closed-door one in 
October 2017 in Dublin. The outcomes of these consultations are presented in this annex.  

On this basis, and considering that the proposed initiative, by its very nature, would not 
directly  affect  retail  consumers  or  investors,  it  has  been  decided  that  no  further  public 
consultation is necessary. 

1.  RESULTS  FROM  THE  ESRB  PUBLIC  SURVEY  ON  SOVEREIGN  BOND-BACKED 

SECURITIES

48 

The ESRB HLTF on safe assets ran an industry survey to consult with stakeholders on 
implementation  of  SBBS.  The 
various  open  questions  regarding 
questionnaire sought feedback on several key issues that have been identified internally 
by the task force, as well as some concerns that have arisen following the bilateral market 
intelligence  meetings.  The  survey  was  published  on 
the  ESRB  website  on 
22 December 2016 and closed on 27 January 2017. 

the  possible 

The survey received 15 credible responses from four investment banks, three commercial 
banks, four asset managers, three funds and one clearing house. The raw data has been 
carefully analysed and various useful insights have emerged. Overall the responses were 
in  line  with  feedback  that  task  force  members  have  received  in  bilateral  meetings,  but 
some unexpected responses were also given (such as  on the expectations for the senior 
bond’s credit rating). A breakdown of answers on key questions and general conclusions 
drawn from the survey are shown below. 

1.1 

Senior SBBS 

To what extent do you perceive a shortage of low-risk and highly liquid euro assets? 

Respondents seem to agree that there is an issue with the supply of safe assets.  

Answer Breakdown: 
2 felt that there is Considerable Shortage 
8 felt there is Partial shortage  
4  do  not  believe  that  there  is  a  shortage  of  safe  assets.  In  particular  1  highlighted  that 
there  is  “No  shortage  in  terms  of  availability  -  the  price  is  just  high,  but  low-risk  and 
highly liquid assets can always be purchased”. 
1 did not answer 

In which asset class would you categorise senior SBBS?  

There seems to be a division amongst market participants as to the asset classification of 
SBBS. This is not inconsistent with the feedback received in Paris and bilateral meetings, 

48 Prepared by staff of the ESRB's Secretariat. The survey itself is introduced at this address: 
https://www.esrb.europa.eu/mppa/surveys/html/ispcsbbs.en.html and presented here: 
https://epsilon.escb.eu/limesurvey/123521?lang=en 

48 

 
                                                      
as  many admitted that they could see  arguments  for an SBBS being both  a bond and a 
structured product.  

Answer Breakdown: 
6 perceive it is a government/supranational bond only 
6 perceive it as a structured product only 
3 perceive as both a bond and a structured product 

One respondent noted that for the Senior SBBS to be classified as a government bond it 
would need to meet structural (“fixed rate, bullet nominal”), regulatory (“ECB collateral, 
solvency  capital  for  banks  and  insurance  equal  to  govies”)  and  market  transparency 
(“rules of issuance, timing”) requirements. 

There are several ways to measure credit risk. How would you score these different 
risk  measures  in  terms  of  their  usefulness  for  evaluating  the  properties  of  senior 
SBBS? 

Probability of Default 

Expected Loss 

Value at Risk 

Expected Shortfall 

Marginal Expected Shortfall 

CoVar 

Very 
Useful 

Useful 

Partly 
Useful 

Not 
Useful 

No 
Answer 

7 

7 

4 

3 

1 

2 

4 

3 

6 

4 

4 

4 

0 

1 

2 

2 

1 

1 

0 

0 

0 

0 

1 

0 

3 

3 

2 

5 

7 

7 

If you have chosen “other” in question 3, above, please elaborate on the additional 
risk measure to which you referred. 

Two  respondents  indicated  that  different  risk  metrics  to  the  one  above  would  be  very 
useful. Specifically one referred to the relationship of SBBS with the euro swap rate. The 
other  hinted  on  the  importance  of  “Stress  loss  under  extreme  but  plausible  market 
conditions” and default correlations. 

One  respondent  indicated  that  “Markets  would  probably  price  this  on  an  expected  loss 
basis (CDO type pricing).” 

What spread (in basis points) would you expect in the yield-to-maturity of 10-year 
senior SBBS relative to 10-year benchmark German bunds? If possible, specify the 
precise expected spread in the free text box. 

Answer Breakdown: 
1 Between -50bp and 0bp 
7 Between 0bp and 50bp 
4 Between 50bp and 100bp 
2 Did not answer 

Which long-term credit rating would you expect to be assigned to senior SBBS?  

At the Paris workshop, several participants expressed scepticism that senior SBBS could 
achieve a AAA rating. However, most survey respondents felt that senior SBBS would 
be rated AAA.  

49 

 
 
 
Answer Breakdown: 
8 AAA  
7 AA 

Low-risk  assets  typically  appreciate  in  value  during  periods  of  stress.  If  perceived 
sovereign  risk  were  to  increase,  would  you  expect  the  value  of  senior  SBBS  to 
increase, stay the same, or decrease? 

Surprisingly, respondents were split on this question. Analytical work done by experts of 
the  task  force  indicates  that  there  is  negative  correlation  between  the  yields  of  the 
tranches  in  stress  times.  Investors  would  flee  from  riskier  securities  and  seek  haven  in 
safe assets. Respondents do not unanimously share this finding, however. 

Answer Breakdown: 
6 Increase 
5 Decrease 
1 Other: “Decrease if Eurozone crisis” 
3 Did not answer 

How important is the liquidity of senior SBBS? 

Respondents perceive liquidity of the senior bond as Very Important. This is in line with 
the feedback perceived in bilaterals and in Paris. 

Answer Breakdown: 
13 Very Important 
2 Did not answer 

To ensure adequate liquidity of senior SBBS, which categories of maturities would 
need to be issued? 

There seems to be a slight preference from respondents for the term  structure of SBBS 
should cover the most liquid points vs the entire curve. 

Answer Breakdown: 
6 Issuance at most liquid points of the curve 
5 Issuance at all points of the curve (from the very short to the very long end) 
4 Did not answer 

To ensure adequate liquidity of senior SBBS, to what extent is it important for them 
to  be  highly  standardised?  Or  could  there  be  some  degree  of  flexibility  (e.g. 
regarding portfolio weights)? 

Respondents clearly prefer a high standardisation of SBBS, which reflects the importance 
of homogeneity across different SBBS series. 

Answer Breakdown: 
9  High  standardisation  –  the  prospectus  should  fix  portfolio  weights  with  no  scope  for 
deviation 
4  Medium  standardisation  –  the  prospectus  should  allow  only  very  limited  deviation 
(within a small min/max range) 
2 Did not answer 

50 

 
What  is  the  minimum  total  notional  value  of  senior  SBBS  necessary  to  ensure 
adequate liquidity? 

Respondents do not seem to agree on an exact figure but consensus is that the notional 
should  be  relatively  high.  Specifically,  most  agree  that  any  size  below  250bn  will  not 
result in a liquid enough market. A relatively high number of participants did not answer 
this question. 

Answer Breakdown: 
2 More than 1500bn 
1 Between 1000-1250bn 
2 Between 500-750bn 
2 Between 250-500bn 
2 Less than 200bn 
6 Did not answer 

What is the minimum monthly issuance of senior SBBS (in terms of notional value) 
necessary to ensure adequate liquidity? 

Similar  to  the  previous  question,  there  is  no  clear  answer  as  to  what  precise  monthly 
issuance  size  can  guarantee  adequate  liquidity.  It  seem  that  a  target  around  the 
EUR 10 billion  mark  could  suffice.  A  relatively  high  number  of  participants  did  not 
answer this question. 

Answer Breakdown: 
1 More than EUR 20 billion 
2 Between EUR 15 billion and EUR 20 billion 
4 Between EUR 10bn and EUR 15 billion 
2 Between EUR 5 billion and EUR 10 billion 
1 Less that EUR 5 billion 
5 Did not answer 

Why might your institution hold senior SBBS? 

Asset-Liability Management (of maturity mismatch) 

Collateral 

Investment Return 

Liability-driven Investment 

Liquid store of value 

Regulatory requirements 

Safe store of value 

Responses 

5 

8 

4 

2 

9 

7 

4 

Assuming that senior SBBS are designed such that they meet your requirements in 
terms  of  credit  and  liquidity  risk,  what  percentage  of  your  institution’s  current 
holdings of central government debt could be replaced by senior SBBS? 

Overall it seems that the substitutability should be quite low in absolute values but it is 
very consistent with an incremental approach to SBBS market development. Answers to 
the  survey  indicate  that  institutions  would  be  willing  to  substitute,  on  average,  around 

51 

 
 
10%  of  their  holdings  into  SBBS.  A  high  number  of  participants  did  not  answer  this 
question. 

Answer Breakdown: 
1 More than 100% 
1 90-100% 
1 20-30% 
2 10-20% 
2 0-10% 
8 Did not answer 

1.2 

Junior SBBS 

In which asset class would you categorise junior SBBS? 

Here we observe that many respondents have different views on senior vs junior SBBS. 
Many indicated that the senior could be classified as a bond think that the junior is only a 
structured  product.  This  divergence  in  perception  is  likely  to  have  arisen  due  to  the 
different  risk  profiles  of  the  two  tranches.  More  risk  averse  market  participants  are 
hesitant  to  see  the  junior  SBBS  being  treated  like  a  bond  (either  in  regulation  or  as  an 
investment opportunity), even though transparency and the look-through approach can be 
applied in the same manner as in the senior SBBS.  

Answer Breakdown: 
3 Bond only 
8 Structured product only 
2 Both bond and structured product 
2 Did not answer 

One  respondent  noted  that  that  junior  SBBS  could  be  perceived  as  a  bond  as  long  as 
structural, regulatory and market transparency rules are satisfied (see the same question 
for senior SBBS above). 

There are several ways to measure credit risk. How would you score these different 
risk  measures  in  terms  of  their  usefulness  for  evaluating  the  properties  of  junior 
SBBS? 

Probability of Default 

Expected Loss 

Value at Risk 

Expected Shortfall 

Marginal Expected Shortfall 

CoVar 

Very 
Useful 

Useful 

Partly 
Useful 

Not 
Useful 

No 
Answer 

6 

5 

4 

3 

2 

2 

3 

4 

3 

3 

2 

1 

0 

0 

1 

0 

0 

2 

0 

0 

0 

0 

1 

0 

5 

5 

6 

8 

9 

9 

If you have chosen “other” in question 2, above, please provide an explanation. 

One  respondent  indicated  that  different  risk  metrics  to  the  ones  above  would  be  very 
useful:  “Stress  loss  under  extreme  but  plausible  market  conditions”  and  default 
correlations. 

52 

 
 
 
Also  one  respondent  indicated  that  “Markets  would  probably  price  this  on  an  expected 
loss basis (CDO type pricing).” 

Which long-term credit rating would you expect to be assigned to junior SBBS? 

7 respondents indicated a non-investment grade rating, while 8 felt the junior could get a 
maximum of BBB. 

What spread (in basis points) would you expect in the yield-to-maturity of 10-year 
junior SBBS relative to 10-year benchmark German bunds? If possible, specify the 
precise expected spread in the free text box. 

A relatively high number of participants did not answer this question. 

Answer Breakdown: 
2 More than 300bp 
3 Between 200bp and 300bp 
3 Between 100bp and 200bp 
1  Other:  “This  would  depend  on  the  credit  rating  achieved  by,  and  the  underlying 
structure of these products.” 
6 Did not answer 

Any mispricing between the replicating portfolio of junior and senior SBBS and the 
underlying  portfolio  could  in  principle  be  arbitraged  away.  To  what  extent  would 
you expect such arbitrage to take place? 

Most  respondents  seemed  to  agree  that  there  will  be  some  excess  spread.  Its  size  is 
debatable  but  the  key  insight  here  is  that  markets  expect  excess  spread  to  exist.  A 
relatively high number of participants did not answer this question. 

Answer Breakdown: 
4 Negligible arbitrage, excess spread would be significant 
5 Some arbitrage, excess spread would be small 
1 Significant arbitrage, excess spread would be negligible 
5 Did not answer 

Would a contractual unbundling option – whereby an investor holding a replicating 
portfolio  of  junior  and  senior  SBBS  could  swap  that  portfolio  for  the  underlying 
sovereign bonds – facilitate arbitrage? 

Respondents  seem  to  agree that  unbundling  would  facilitate  arbitrage, albeit  to  varying 
degrees. A relatively high number of participants did not answer this question. 

Answer Breakdown: 
2 Yes, unbundling option is critical for arbitrage to work 
3 Yes, but arbitrage will work even without the unbundling option 
2 Somewhat but other frictions would still prevent full arbitrage 
1 No, unbundling option would not work, and arbitrage will be limited 
7 did not answer 

53 

 
Would junior SBBS’ property of embedded leverage enhance their attractiveness in 
terms of expected return?  

There  seems  to  be  an  agreement  that  the  embedded  leverage  property  of  SBBS  could 
play a role in attracting higher demand. A high number of participants did not answer this 
question. 

Answer Breakdown: 
2 Certainly yes 
4 Probably yes 
1 Maybe 
8 Did not answer 

Would sub-tranching junior SBBS for example in the form of a 15%-thick tranche 
of equity SBBS and a 15%-thick tranche of mezzanine SBBS enhance total demand 
for the securities? 

Answers are consistent with market intelligence meetings, where market contacts showed 
more willingness to invest in a mezzanine tranche rather than a 30% thick first loss piece.  

Answer Breakdown: 
2 Certainly Yes 
6 Probably Yes 
2 Maybe 
2 Probably No 
3 Did not answer 

One  of  the  “Probably  no”  respondents,  provided  further  clarification  for  his  answer. 
Specifically,  they  believe  that  a  mezzanine  tranche  could  enlarge  potential  investors  at 
the  detriment  of  the  placing  capabilities  of  the  smaller  and  riskier  junior  tranche.  The 
only  caveat  to  that  would  be  to  ensure  that  the  structure  is  eligible  for  amortizing  cost 
under  IFRS  9.  Such  eligibility  is  achieved  only  if  there  is  a  tranche  below  the  bond  in 
question  and  the  mezzanine  bond  could  achieve  it.  They  see  the  lack  of  existence  of 
amortising cost treatment as a non-starter for many potential buyers. 

How important is the liquidity of junior SBBS? 

Respondents feel that liquidity of the junior bond is important but not the same extent as 
for the senior bond. 

Answer Breakdown: 
5 Very Important 
4 Important 
1 Neutral 
1 Not Important 
4 Did not answer 

54 

 
To ensure adequate liquidity of junior SBBS, to what extent is it important for them 
to be highly standardized in a master prospectus? Or could there be some degree of 
flexibility (e.g. regarding portfolio weights)? 

Similar to the senior bond, there is a lot of merit in having a high degree of homogeneity 
among  different  SBBS  series.  A  relatively  high  number  of  participants  did  not  answer 
this question. 

Answer Breakdown: 
7  High  standardization  -  the  prospectus  should  fix  portfolio  weights  with  no  scope  for 
deviation 
2  Medium  standardization  -  the  prospectus  should  allow  only  very  limited  deviation 
(within a small min/max range) 
6 Did not answer  

Why might your institution hold junior SBBS? 

Asset-Liability Management 
(of maturity mismatch) 

Collateral 

Investment Return 

Liability-driven Investment 

Liquid store of value 

Regulatory requirements 

Safe store of value 

Responses 

0 

2 (provided it is accepted by the ECB) 

6 

0 

1 

1 

1 

Other reasons: Market making and hedging.  

Note that MMFs and CCPs indicated that the junior bond would not be eligible for them 
to hold. 

Assuming that junior SBBS are designed such that they meet your requirements in 
terms  of  credit  and  liquidity  risk,  what  percentage  of  your  institution’s  current 
holdings of central government debt could be replaced by junior SBBS? 

Respondents mentioned very low degree of substitutability (expected given the different 
nature  and  perception  of  junior  SBBS  relative  to  central  government  bonds).  A  high 
number of participants did not answer this question. 

Answer Breakdown: 
1 10-20% 
2 0-10% 
2 0% 
10 did not answer 

What changes to the design of junior SBBS would make them more attractive? 

Some participants feel that the junior SBBS does not offer enough to motivate outright 
investment.  The  feedback  received  from  answers  to  the  open  question  was  that  there 
must be additional buffers to protect from the high risk exposure. Some proposals are: 

  “A third tranche” 

55 

 
 
  “Since  the  junior  would  resemble  Greece  (and  get  similar  characteristics)  a  5% 
equity tranche placed at the ESM (with partial corresponding reduction of the Greece 
program) should be introduced.” 

  “Public issuance and guarantee” 

  “Overcollateralization” 

  “Ensure bullet nominal structure by 

o  an  exact  matching  of  capital  redemption  for  bond  constituents  and  SBBS 

Notes 

o  a similar timing for the issuance of the SBBS and the bond constituents 

  Also a Fixed rate bond requires a good certainty of coupon payments. If the bonds 
are  paying  different  coupons  at  different  payment  dates,  best  would  be  to  have  a 
small  coupon  to  ensure  good  coupon  coverage  and  certainty,  with  a  mechanism  to 
deal with excess spread, and some adjustment of the issue price to adjust the junior 
SBBS yield.” 

1.3 

Regulation 

What  areas  of  regulation  currently  disincentivise  the  development  of  SBBS? 
Explain your answer in the free text field. 

Yes  Comments 

Capital Regulation for banks 

5 

Liquidity Regulation for banks 

5 

Insurance regulation 

Investment fund regulation 

Pension fund regulation 

Capital bank collateral 
eligibility 

Other 

2 

1 

1 

3 

3 

“0% risk weight necessary” 
“Large Exposure Limits, Leverage Ratio, Capital 
Requirements” 
“they are a structured product” 

“HQLA eligibility is key for banks” 
“LCR” 
“Would need 100% liquidity against them” 
“SBBS should be LCR eligible” 

“Solvency 2“ 

“Eligibility as collateral by the ECB is key for banks” 
“SBBS should be an eligible asset with a haircut 
corresponding to its reduced risk” 

“all regulation types should adjust to these instruments for 
acceptance as collateral or 'safe assets’”  
“Index rules and guidelines” 
“individual sovereign risks can be accessed through present 
markets. little value in bundling risks without sharing them.” 

Other Comments:  

  “We  do  not  support  a  change  in  the  current  banking  regulation  for  sovereign 
exposures.  Nevertheless,  we  consider  that  the  success  of  Senior  SBBS  would 
somehow be linked to this regulatory change in the underlying assets.” 

  “Solvency capital requirements for banks and insurance holding the SBBS should be 
similar  to  those  of  govies:  no  capital  charge,  no  securitisation  treatment,  no 
concentration risk.” 

56 

 
 
 
 
In your opinion, in the regulatory framework, should SBBS be treated according to: 

This  result  confirms  the  work  of  Workstream  B  of  the  task  force,  which  is  operating 
according  to  the  look-through  approach.  It  is  also  in  accordance  with  the  feedback 
received in meetings, where participants felt that it would be unfair to SBBS if the look-
through approach was not applied. Answers to the question are strongly in favour of the 
look-through approach: 

Answer Breakdown: 
10  Look-through  approach  (two  emphasized  that  it  should  get  0%  rw  even  with  a 
possible introduction of RTSE) 
3 Current regulation on securitised products 
2 did not answer 

How should voting rights be allocated? 

Respondents  concluded  that  voting  rights  should  be  allocated  according  to  investors’ 
holdings. A high number of participants did not answer this question. 

Answer Breakdown: 
3 Voting rights should be transferred to investors in proportion to their holdings of junior 
and senior SBBS 
1 Voting rights should be transferred to investors in proportion to their holdings of senior 
SBBS 
1 Voting rights should be concentrated in the special vehicle 
10 did not answer 
1 respondent commented that “a trustee should handle the voting rights and represent the 
Noteholders.” 

What other considerations should inform the design of a regulatory framework for 
SBBS? 

Answers:  

  “EMIR regulation change to allow recognition of full portfolio margining benefits on 

SBBS.” 

  “A  guaranteed  repo  market  or  liquidity  provider  available  to  exchange  SBBS  for 
cash to post as collateral for variation margin under centrally cleared swaps would be 
highly important to us.” 

  “If  they  are  anything  other  than  pari-passu  with  governments  from  a  regulatory 
perspective  the  project  will  not  work.  Likely  there  will  have  to  be  a  relative 
advantage to hold them, to encourage the market initially.” 

  “The  success  of  ESBies  is  conditional  to  its  regulatory  treatment  in  banking, 
insurance and pension funds regulation. For ESBies, an special treatment should be 
granted in the following areas: 

o  Credit  risk:  ESBies  should  not  follow  the  current  regulation  for  securitized 
products.  Instead,  they  should  receive  a  0%  risk  weight  that  reflects  their 
condition as a risk-free asset. 

o  Liquidity risk: ESBies need to be recognized as a High Level Liquid Asset, so 

that they are eligible to comply with the Liquidity Coverage Ratio. 

57 

 
o  Market risk: In line with credit and liquidity risk, ESBies should also keep the 

preferential treatment that now is granted for national sovereign debt. 

o  Moreover,  and  to  reflect  the  own  nature  of  ESBies  as  a  diversified  asset,  they 

should be exempted from the large exposure limit. 

o  Finally, it is also necessary that they are recognized by the ECB as collateral for 
monetary  policy  operations  and  also  by  Central  Counterparties  in  market 
operations. 

It is necessary to consider that the previous regulatory adjustment would need a 
greater  one,  which  is  the  change  of  the  current  regulatory  treatment  of  the 
underlying  assets,  that  is  to  say  national  sovereign  exposures.  This  potential 
change  would  come  with  great  challenges  itself  and  should  be  designed  and 
implemented  globally,  to  avoid  creating  an  un-levelled  playing  field  across 
jurisdictions.” 

1.4 

Economics of SBBS issuance 

What  are  the  reasons  for  the  current  non-existence  of  sovereign  bond-backed 
securities? 

Both  the  task  force  and  feedback  from  the  market  intelligence  meetings  stressed  that 
regulation has been the main impediment. Even though respondents seem to agree with 
that, it is interesting to note that they have also cited various other reasons that have not 
been considered so far. 

Answer Breakdown: 
1 The regulation of both sovereign bonds and securitised products 
6 The regulation of securitised products 
1 The regulation of sovereign bonds 
5 Did not answer 
5 Other citations:  

  Structuring costs 
  Warehousing and execution risks  
  High degree of complexity  
  2 people felt that the sum of its parts has little to offer compared to the individual 

components  

  1  indicated  that  “Until  now  there  was  not  a  perceived  market  shortage  of  low-risk 
and highly liquid assets, so there was no need of SBBS under the current regulatory 
framework.” 

What would be the most significant operational fixed and variable costs related to 
SBBS issuance? 

Special servicer fees 

Trading costs 

Credit rating fees 

Legal costs 

Administrative costs 

Costs related to funding the warehouse 

Yes 

2 

2 

2 

2 

2 

2 

58 

 
 
Other comments:  
  capital cost / balance sheet use (ROE) 
  regulatory burden of holding 
  similar to that of ETF(those above + observability) 

It is interesting to note that one respondent believes that “Issuance costs (rating, servicer, 
administrative, legal costs) are probably minimal given the size expected”. 

Would it be most practicable for assembly of the underlying portfolio to take place 
via  purchases  of  central  government  bonds  on  the  primary  markets,  purchases  on 
the secondary markets, or by using existing portfolios? 

We observe a very interesting conclusion here. Respondents did not feel that the primary 
market is a necessary condition for successful issuance. This is contrary to the suggestion 
in  the  Industry  Seminar  that  DMO  coordination  would  be  vital  (or  the  best  solution 
operationally) for the success of the issuance process. 

Answer Breakdown: 
7 New purchases from the primary market 
3 New purchases from the secondary market 
3 Use existing portfolios 
3 cannot know 
2 did not answer 

One respondent noted that the secondary market could be used to recycle the bonds the 
Eurosystem already holds. 

Given  the  current  characteristics  of  primary  and  secondary  government  bond 
markets,  would  it  be  feasible to  assemble  the  underlying  portfolio  and  place  all  of 
the  corresponding  senior  and  junior  SBBS  within  one  week,  using  all  available 
technical devices (e.g. advanced book-building)? 

Of those that answered most feel that it would be possible. This implies may not be a big 
impediment for an issuer to overcome. A relatively high number of participants did not 
answer this question. 

Answer Breakdown: 
1 Yes 
3 Probably Yes 
2 Probably not 
3 Cannot Know 
6 did not answer 

It is worth noting that none of those who answered “Probably Not” feel that warehousing 
is a significant cost. Of the 2 people who answered “Cannot Know”, 1 thinks that such 
cost  would  be  recouped  by  revenues  but  the  other  believes  that  warehousing  is  a  Very 
Significant cost. 

To  what  extent  would  coordinated  DMO  issuance  in  the  primary  market  help  to 
alleviate this warehousing problem? 

Respondents agree that DMO coordination would help in alleviation of the warehousing 
problem. A high number of participants did not answer this question. 

59 

 
Answer Breakdown: 
3 Significant Alleviation 
2 Partial Alleviation 
1 Not relevant or necessary, as the warehousing problem is anyway minimal 
9 did not answer 

In view of the likely fixed and variable cost structure of SBBS issuance, how many 
different SBBS issuers do you expect that the market could sustain in equilibrium? 

Respondents do not feel that there is enough room in the market for many issuers. A high 
number of participants did not answer this question. 

Answer Breakdown: 
2 2-5 issuers 
5 1 issuer 
8 Did not answer 

Could  SBBS  issuance  be  a  profitable  operation?  Explain  your  answer  in  the  free 
text field. 

Most  respondents  could  not  give  a  definitive  answer,  but  some  positive  feedback  was 
received.  It  is  interesting  to  look  at  the  comments  provided  in  the  free  text  field,  as  4 
respondents  feel  that  SBBS  issuance  would  be  a  profitable  operation  provided  that 
certain preconditions are met. 

Answer Breakdown: 
2 Yes (“The  consolidated yield  of SBBS could in the end become  more attractive  than 
the yield combination of the underlying components, provided the product structuring is 
made in a way to drive the market to consider those products as standalone credits rather 
than structured products (hence 1 single public issuing entity, high standardization, large 
volumes by issue (benchmark+taps), dedicated DMO issues to avoid duration mismatch 
costs,  warehousing  costs,  complexity,  and  capacity  to  build  exact  same  portfolio  for 
arbitrages.”) 
2 Probably Yes (“trading spreads and short term funding profits of unsold bonds”) 
6 Cannot Know 
5 Did not answer 

Who should arrange and service the special vehicle? 

Respondents  are  clearly  in  favour  of  a  public  entity  issuing  SBBS.  This  result  is  very 
much  in  line  with  feedback  in  other  fora,  where  investors  have  stated  that  they  would 
prefer  some  form  of  public  guarantee.  Even  if  the  SBBS  are  in  the  balance  sheet  of  a 
privately owned institution, any involvement of a public entity would provide assurance. 

Answer Breakdown: 
9 Public Sector entity 
1 Public-private entity 
5 Did not answer 

60 

 
Insofar  as  the  special  vehicle  is  arrange  by  private-sector  entities,  would  these 
private-sector entities necessarily be primary dealers on sovereign debt markets, or 
could other types of entities do the job? 

Respondents  seem  to  agree  that  primary  dealers  should  be  arranging  the  SBBS  issuing 
entity. A high number of participants did not answer this question. 

Answer Breakdown: 
5 Yes - primary dealers have a natural advantage in arranging SBBS vehicles. 
2  No  -  SBBS  vehicles  could  be  arrange  by  other  financial  institutions  as  well  as  (or 
instead of) primary dealers 
8 Did not answer 

Would your institution consider becoming an SBBS issuer? 

Most of the institutions that answered the survey do not have any experience as primary 
dealers so it is unlikely that they would ever engage in SBBS issuance. Those institutions 
that  would  consider  issuing  would  do  so  only  if  there  were  considerable  regulatory 
sponsorship and enough demand. One respondent stated that their institution would only 
consider being an arranger and not an issuer. 

Answer Breakdown: 
1 Yes 
7 No  
3 Under Certain conditions 
4 Did not answer 

One respondent indicated that they would consider being market makers of SBBS. 

What changes in the regulatory or market environment would make SBBS issuance 
more attractive? 

Most  of  the  responses  hinted  to  the  importance  of  changing  the  regulatory  regime. 
Specific comments can be seen below:  

  “Promote them above ordinary derivatives through regulation.” 

  “Lower regulatory capital cost.” 

  “Pari - passu or better ranking vs euro area government bonds” 

  “Look through acceptability, not considered as securitisation” 

  “As stated before, we consider that the success of Senior SBBS is conditional to their 
regulatory  treatment  (they  should  receive  a  beneficial  treatment  in  terms  of  credit, 
market and liquidity risk and in terms of large exposures limits) and to the regulatory 
treatment of the underlying assets. Moreover, they should be recognised by the ECB 
as  collateral  for  monetary  policy  operations  and  also  by  Central  Counterparties  for 
market  operations.  Nevertheless,  we  consider  it  key  that  any  changes  need  to  be 
implemented  at  one  time.  Europe  cannot  afford  to  be  stuck  half-way  of  the 
implementation process of such a change.” 

  “Change in the design of the risk, effective liquidity in the market for SBBS which 

suppose there is a real need for this product among the investors.” 

  “Arbitrage  free  haircuts  of  SBBS  and  bond  constituents,  similar  liquidity  of  SBBS 

and constituents” 

61 

 
What  do  you  expect  to  be  the  likely  impact  of  SBBS  on  market  conditions  for 
sovereign bonds? 

This  is  an  open  question  and  a  single  conclusion  cannot  be  drawn.  There  were  mixed 
responses, with many assuming a negative impact. All the answers are illustrated below.  
  “It depends on their popularity and demand. I am sceptical that they will become a 

large portion of the market.” 

  “Less sovereign bonds direct issuance” 
  “Less  supply,  but  also  less  demand,  possibly  leading  to  difficulty  establishing  a 

liquid curve for some issuers.” 

  “Negative  impact  on  spreads  and  liquidity  on  some  of  the  underlying  sovereign 

bonds.” 

  “In theory if they are successful then government bond liquidity will decline as more 
bonds go into SBBS. Market determination of intra-EMU spreads will be challenging 
as they will reflect liquidity more than fundamentals.” 

  “With the introduction of SBBS as a new asset class the current void in the middle of 

the European sovereign debt market spectrum would be filled.” 

  “Very limited, if issuance came from publicly held debt” 
  “If successful, they would extract attractive reserve assets but may reduce liquidity in 

individual country Eurozone bonds.” 

  “We think that It is likely that for some countries, the expected sovereign issuances 
are  higher  than  their  participation  in  ESBies,  leaving  a  remaining  pool  of  national 
debt in national sovereign markets. The implicit reduction of these markets will have 
significant  negative  consequences  for  sovereign  debt  not  included  in  the  pool  for 
ESBies. These bonds will face a sharp decrease in its liquidity, increasing liquidity 
the  premia  and  negatively  affecting  the  operations  in  these  markets,  with  increased 
transaction costs. A solution needs to be foreseen for this type of situations.” 

  “It really depends on the SBBS reaching the level where they are liquid.” 
  “The SBBS would contribute to the emergence of an harmonised EU sovereign bond 
market,  with  some  mutualisation  achieved  through  structural  features  rather  than 
policy making.” 

2.  SUMMARY OF THE INDUSTRY WORKSHOP

49 

On 9 December 2016, the ESRB held an industry workshop on Sovereign Bond-Backed 
Securities (SBBS), hosted by the Banque de France. The purpose of the workshop was 
to  discuss  the  feasibility  of  creating  a  market  for  SBBS.  Discussions  were  held  under 
Chatham  House  rules.  This  summary  of  proceedings  is  intended  to  capture  in 
anonymised form the main insights emerging from each session.  

The  workshop  revealed  a  broad  diversity  of  views  with  respect  to  SBBS’  feasibility. 
Overall, participants underlined the necessity for deeper financial integration in Europe. 
There was a mix of views as to whether SBBS represent the correct product with which 
to  achieve  deeper  integration:  some  participants  expressed  fundamental  scepticism, 
while  some  others  thought  that  a  functioning  market  for  the  securities  could  develop 
under certain conditions. The discussions delivered a set of useful insights to inform the 

49 This summary was prepared by staff of the ESRB's Secretariat.  

62 

 
                                                      
ongoing work of the ESRB High-Level Task Force, which currently has an open mind 
with respect to all aspects of security design. 

Several  participants  in  the  ESRB  industry  workshop  referred  to  ESRB  Working  Paper 
no.21 in their remarks. They saw it as a natural reference point, since the working paper 
represents the original inspiration behind the creation of ESRB High-Level Task Force 
on  Safe  Assets.  However,  the  task  force  is  not  an  intellectual  prisoner  to  the  working 
paper. In several ways, internal thinking in the task force has diverged from the working 
paper,  following  policy  discussions.  For  example,  the  task  force  envisages  a 
considerably  smaller  size  of  the  SBBS  market  than is suggested in  the  working  paper. 
Insights from the workshop will allow the task force to further develop and enrich the 
basic idea of Sovereign Bond-Backed Securities. 

Session 1: Motivation 

Session participants defined “safe” in terms of low liquidity risk, low volatility risk and 
low  default  risk.  “Safety”  is  therefore  a  relative  concept  along  these  three  dimensions. 
One participant emphasised the importance of low liquidity risk and low volatility risk in 
(the  creation  of)  “safe  assets”:  while  important,  low  default  risk  was  second-order,  in 
their view. This  implies that an SBBS  market should  be liquid first  and foremost.  Two 
participants  agreed  that  a  liquid  SBBS  market  could  be  achieved  by  announcing  a 
calendar  of  regular  issuance,  such  that  market  players  would  have  a  reasonable 
expectation  of  large  volume  in  steady-state.  In  addition,  SBBS’  design  should  be  as 
simple  as  possible,  such  that  even  relatively  unsophisticated  investors  would  be 
comfortable  trading  and  holding  them.  Corresponding  repo  and  futures  markets  would 
also need to be developed to ensure liquidity. One participant emphasised the importance 
of the securities’ inclusion in benchmark indices. 

One  participant  pointed  to  the  role  of  (Senior)  SBBS  in  generating  a  euro  area  wide 
benchmark risk-free rate curve. At present, many market players use national curves for 
discounting. This exacerbates financial fragmentation, particularly in an environment in 
which cross-country spreads are high. Moreover, a full term-structure of maturities would 
help to boost SBBS’ market liquidity. 

One  expressed  scepticism  regarding  safe  asset  scarcity,  but  also  emphasised  that 
Eurobonds, embedding joint liability among nation-states, would be preferable to SBBS. 
In  their  view,  “synthetic  Eurobonds”  (i.e.  SBBS)  without  joint  liability  may  pose  a 
problem  for  certain  investors  reluctant  to  hold  structured  products.  Moreover,  the 
creation  of  SBBS  may  send  a  (negative)  signal  to  markets  regarding  the  limits  of 
European ambition. There is also a communication challenge related to the proposed new 
treatment  of  simple  and  transparent  securitizations  and  its  interaction  with  a  policy 
announcement  pertaining  to  the  creation  of  an  SBBS  market.  On  the  other  hand,  a 
successful SBBS market could help to revive the broader European securitization market. 
Nevertheless, the issuance of a new securitization product is seen as challenging in view 
of these instruments’ history over the financial crisis. 

Participants  broadly  agreed  that  an  SBBS  market  would  need  initiation  by  the  public 
sector, including via:  

63 

 
  DMO  coordination:  DMOs  could  coordinate  issuance  for  the  fraction  of  their 

calendar that is intended for SBBS.  

  Regulatory  treatment:  A  necessary  condition  for  the  creation  of  an  SBBS  market 
would be the application of a “look-through approach” to the regulatory treatment of 
SBBS,  such  that  they  would  be  treated  consistently  with  the  underlying  sovereign 
bonds.  Without  consistency  of  treatment,  would-be  investors  would  (be  forced  to) 
treat  SBBS  as  structured  products,  both  in  terms  of  regulation  and  with  respect  to 
their investment mandates, thereby shrinking the investor base. For one participant, 
a  regulatory  treatment  of  sovereign  bonds  that  imposed  soft  or  hard  concentration 
charges  would  encourage  marginal  portfolio  shifts  in  favour  of  SBBS.  This  was 
deemed preferable to risk-based capital charges. 

  Simplicity:  SBBS  should  share  the  characteristics  of  straightforward  fixed  income 
securities. A simple structure – with fixed portfolio weights on the asset side, and a 
maximum of three tranches on the liability side – would encourage investors to view 
SBBS as a bond rather than as a structured product. 

  Liquidity: The SBBS market should be liquid, including in the build-up phase, when 
volumes  are  below  those  in  steady-state.  Liquidity  would  be  supported  by  a 
transparent  timetable  of  SBBS  issues,  such  that investors  would  have  a  reasonable 
expectation of adequate volumes.  

  Clear  restructuring  procedures:  Investors  need  clarity  regarding  the  work-out 

procedure in the event of a (selective) sovereign default. 

Session 2: Sovereign debt markets 

Session  2  participants  emphasised  the  importance  of  DMOs’  objective  of  minimizing 
borrowing costs to the taxpayer. Part of these costs is due to the liquidity premia paid by 
DMOs.  It  is  therefore  important  to  minimize  liquidity  premia  by  ensuring  continued 
liquidity  in  existing  sovereign  debt  markets.  The  SBBS  market  should  therefore  be 
designed  in  a  way  that  does  not  impair  liquidity  in  underlying  sovereign  debt  markets. 
Although  one  participant  emphasized  that  SBBS  would  harm  price  discovery  on 
sovereign debt markets, most thought that a gradual (rather than rapid) development of an 
SBBS market – initially in “experimental” or “proof of concept” fashion – would be the 
least disruptive. Gradual development would allow market players and regulators to learn 
about  the  impact  on  secondary  market  liquidity  and  to  calibrate  the  program 
accordingly.50 

At  the  same  time,  Session  2  participants  reiterated  the  main  insight  of  Session  1 
regarding  the importance of ensuring SBBS  market  liquidity. This  could be compatible 
with a slow, experimental approach to market development if investors were to harbour 
reasonable  expectations  regarding  the  steady-state  size  of  the  SBBS  market.  With  a 
transparent  calendar  of  regular  and  moderately  sized  issuances,  several  participants 

50 In another session, a workshop participant noted that a fraction of the underlying portfolio could be used in 
repo transactions. This could generate income for the SPV arranger – thereby encouraging new entrants to 
capture such expected profits – and alleviate collateral scarcity in sovereign bond markets. As such, this 
proposal could alleviate concerns regarding the impact on secondary market liquidity. 

64 

 
                                                      
expressed confidence  that adequate SBBS  market liquidity would emerge, aided by the 
development of functioning repo and futures markets. 

Some  participants  expressed  reluctance  to  build  a  regulatory  treatment  that  would  be 
attractive for SBBS while penalising existing sovereign debt.  

Participants thought that the most  feasible way to  gradually introduce an SBBS  market 
would be for DMOs to coordinate issuance on the fraction that is intended for SBBS, for 
example by pre-agreeing to execute a (private) placement of their bonds with an SBBS-
issuing  entity.  Moreover,  bonds  would  ideally  be  homogenous  in  terms  of  their 
characteristics  (e.g.  maturity,  coupon),  thereby  ensuring  commonality  of  cash  flows  to 
the SBBS-issuing entity over its lifetime. Most bonds would continue to be sold using the 
existing mix of placements, syndications and auctions; the current market microstructure 
would  therefore  persist,  thereby  limiting  the  effect  of  SBBS  on  secondary  market 
liquidity, and ensuring DMO autonomy with respect to the timing and characteristics of 
the (vast) majority of their issuance calendar. 

With regard to market making activities, one participant said that market making for the 
senior  tranche  might  be  possible,  while  market  making  in  the  junior  tranche  would  be 
more difficult. Moreover, the profitability for market makers might be lower in the SBBS 
market than on current national sovereign debt markets. 

Session 3: Commercial banks 

As  in  earlier  sessions,  several  participants  expressed  scepticism  regarding  a  regulatory 
regime  that  would  impose  risk-based  capital  charges  on  sovereign  debt.  Instead, 
participants favoured incentives for diversification to alleviate banks’ current home bias. 
SBBS could represent such an incentive for diversification, particularly if coupled with 
soft charges for concentrated portfolios. At the same time, for some participants such a 
home bias is a rational behaviour, aiming at minimising asset-liability mismatches.  

In  general,  participants  expected  that  the  yield  on  Senior  SBBS  would  have  a  positive 
spread with respect to comparable German bunds, particularly in the early stages of the 
market when liquidity would be at its thinnest. One participant said that the Senior SBBS 
yield would most likely be somewhere between the German bund yield and ESM bond 
yield. 

Several  Session  3  participants  emphasised  the  attractiveness  of  the  broad  asset  class  of 
supranational  and  sub-sovereign  debt,  which  offers  moderate  pick-up  in  terms  of  yield 
for the same regulatory treatment as central government bonds. SBBS could tap into this 
existing  investor  base,  conditional  on  regulatory  changes  that  would  carve-out  SBBS 
from  the  existing  treatment  of  structured  products.  An  analogy  is  provided  by  covered 
bonds, for which the existence of strong national laws ensures low spreads. On the other 
hand,  one  participant  thought  that  a  consistent  treatment  of  SBBS  relative  to  the 
underlying would be insufficient to engineer demand for SBBS. Banks in core countries 
would  still  be  reluctant  to  rebalance  their  portfolios  towards  Senior  SBBS  (owing  to 
worries regarding redenomination risk), whereas banks in vulnerable countries would be 
reluctant  to  forego  the  high  returns  expected  from  holding  domestic  sovereign  debt.  In 
their view, regulators would need to implement a favourable treatment of SBBS (relative 

65 

 
to  the  underlying),  but  this  would  have  the  undesirable  side  effect  of  crowding-out 
demand for the remaining float of national debt. 

Several  participants  argued  that  the  proposed  calibration  for  the  junior  tranche  (30%) 
would  be  too  high  relative  to  the  size  of  the  potential  investor  market.  In  this  respect, 
sub-tranching would reduce the size of the high-yield first-loss piece that would need to 
be placed with investors but would add to the complexity of the product. 

One  participant  highlighted  a  dilemma  whereby  –  on  the  one  hand  –  SBBS  issuance 
entails  a  natural  monopoly,  but  public-sector  issuance  of  SBBS  would  entail  implicit 
risk-sharing among nation-states. Overcoming this dilemma would require changes to the 
features of SBBS issuance that imply natural monopoly. One such change could be the 
coordinated DMO issues suggested in Session 2. 

Session 4: Non-bank Investors 

Session 4 participants began  by highlighting  their  reasons for  holding sovereign bonds. 
Several  participants  pointed  to  the  role  of  liability-driven  investment,  which  calls  for 
long-dated,  fixed-income  assets.  For  these  buy-and-hold  investors,  liquidity  is  less 
important; instead, what matters is low credit risk combined with non-negative returns. 

Participants  emphasised  that  the  attractiveness  of  SBBS  is  a  relative  value  proposition. 
Investment  decisions  would  be  based  on  SBBS’  expected  risk/return  relative  to  other 
investible assets.  

  One  participant  expressed  a  preference  for  Senior  (rather  than  Junior)  SBBS, 
conditional on regulatory reform that would define SBBS as sovereign bonds rather 
than structured products. To be used as a duration instrument, Senior SBBS would 
ideally need to be rated AAA, with a moderate pick-up compared with other AAA-
rated assets. Transactions costs for trading SBBS would also need to be low.  

  Another participant claimed that risk managers would treat SBBS as a securitization, 
regardless  of  the  existence  of  regulation  that  may  define  it  otherwise.  This  could 
impede the extent to which Senior SBBS could be used to manage duration risk. 

  Another  participant  claimed  that  redenomination  risk  should  be  taken  into  account 

because it influences ratings and pricing. 

  A third participant said that they may hold Junior SBBS in (relatively niche) funds 
that permit holdings of structured products. In their view, Senior SBBS would only 
be  held  by  sovereign  bond  funds  if  they  were  to  comprise  part  of  the  benchmark 
against  which  performance  is  evaluated.  In  general,  holding  Senior  SBBS  in  a 
sovereign bond fund would be difficult or  impossible in the absence of changes to 
the mandates of such funds that otherwise prohibit holdings of structured products. 
This would require investors to perceive SBBS as a non-securitised product. 

  Two participants claimed that the “maths don’t add up” in terms of the likely yield 
on  Senior  and  Junior  SBBS  relative  to  the  underlying.  In  their  view,  prospective 
holders of Junior SBBS would require a very high return, such that the Senior SBBS 
yield would be negative in the current environment. 

66 

 
Session 5: Demand for junior SBBS 

Session  participants  agreed  that  regulatory  change  would  be  necessary  to  ensure  the 
success of an SBBS market – echoing earlier contributions. One participant noted that – 
even with regulatory reform – holders of SBBS would continue to bear “regulatory risk” 
(as  the  future  framework  could  again  be  changed  to  penalize  SBBS,  just  as  recent 
reforms have penalized ABS). 

Participants  discussed  the  size  of  the  potential  investor  base  for  Junior  SBBS.  One 
participant  said  that  Junior  SBBS  represents  “high  octane”  sovereign  risk,  and  would 
therefore compare naturally to emerging market sovereign debt. There is an investor base 
for  such  risk  exposure, but  it  is  relatively  niche.  Another  participant  said  that  investors 
would  evaluate  the  relative  attractiveness  (in  terms  of  risk/return)  of  Junior  SBBS 
compared  with  (high-yield)  corporate  bonds.  This  suggests  finite  investor  capacity  for 
high-yield  debt  instruments.  As  such,  there  may  be  a  natural  limit  on  the  size  of  the 
SBBS market. The point at which this limit is reached could be identified by a step-by-
step approach to growth in the SBBS market. 

Several  participants  expressed  concerns  regarding  high  correlations  between  the 
underlying  sovereign  bonds’  probabilities  of  default.  The  unconditional  probability  of 
sovereigns’  default  is  lower  than  the  default  probability  conditional  on  the  default  of 
(other)  sovereigns.  Modelling  such  conditional  probabilities  is  difficult,  however,  and 
subject to considerable parameter uncertainty. Before the crisis, the market had amassed 
a rich stock of expertise capable of pricing such securities in the presence of parameter 
uncertainty.  While  this  expertise  has  now  atrophied,  it  could  be  revived  by  an  active 
SBBS market. 

One  participant  noted  that  collateralized  debt  obligations  require  a  positive  arbitrage 
margin in order to generate profits. Some prospective CDOs generate a negative arbitrage 
margin,  and  do  not  function  for  that  reason.  The  same  challenge  applies  to  SBBS.  To 
maximize the probability of a positive arbitrage margin, SBBS issuer(s) could engage in 
“ratings  optimization”  with  respect  to  the  tranches.  This  suggests  that  at  least  three 
tranches  would  be  warranted  (namely  first-loss,  mezzanine  and  senior).  Such  investor 
catering could be done by the market via “re-securitizations”, conditional on regulatory 
reform to accommodate SBBS2 as well as SBBS. 

One participant argued that SBBS could increase the probabilities of sovereigns’ defaults 
in  equilibrium.  Default  would  be  less  costly  insofar  as  banks  rebalance  their  sovereign 
portfolios away from their current home-biased holdings in favour of Senior SBBS. This 
changes sovereigns’ cost/benefit calculation, as a default would be less destructive for the 
domestic  banking  sector  and  therefore  for  the  functioning  of  the  real  economy.  At  the 
margin,  then,  widespread  holdings  of  Senior  SBBS  in  the  banking  sector  could  make 
sovereign default more likely. 

Session 6: Risk measurement 

All  participants took  a generally conservative approach to SBBS’  risk measurement.  In 
terms  of  credit  risk,  this  implies  an  underlying  assumption  of  high  correlations  during 
stress  events.  In  terms  of  liquidity  risk,  this  implies  a  working  assumption  of  low 
liquidity until proven otherwise. 

67 

 
Several  participants  noted  that  correlation  among  underlying  sovereign  bonds’  default 
probabilities  is  important  for  measuring  SBBS’  risk  but  difficult  to  quantify.  A 
conservative  approach  would  assume  high  correlations,  particularly  during  crisis 
episodes.  Very  high  correlations  would  imply  that  the  Senior  SBBS  would  struggle  to 
achieve  a  top  rating  with  30%  subordination,  particularly  given  that  the  underlying 
portfolio  is  “lumpy”  as  it  is  comprised  of  just  19  sovereigns  (so  that  discrete  default 
events have large effects).  

One participant noted that the probability of default of the Junior SBBS would be at least 
as  high  as  the  highest  probability  of  default  in  the  underlying  portfolio.  Some  credit 
ratings  take  expected  recovery  rates  into  account,  such  that  Junior  SBBS  could  benefit 
from  a  better  rating  than  implied  by  its  probability  of  default,  but  it  was  noted  that 
recovery rates are subject to a high degree of uncertainty. Another participant emphasised 
the  importance  of  achieving  clarity  ex  ante  on  the  work-out  arrangements  for  Junior 
SBBS in the event of a default on the underlying bonds.  

3.  MAIN TAKEAWAYS OF THE CLOSED-DOOR DMO WORKSHOP 

The HLTF organised a closed-door workshop with DMOs on 20 October 2017 in Dublin. 
The  workshop  intended  to  offer  DMOs  an  opportunity  to  express  their  views  on  the 
SBBS proposal and to seek their expertise on specific (technical) issues. 

DMOs  raised  concerns  regarding  the  design  and  implementation  of  SBBS  and 
highlighted that, in their view, SBBS would not be the appropriate tool to break the bank-
sovereign nexus nor to implement a euro area low-risk asset. More specifically, DMO's 
concerns  related  to  the  impact  on  national  sovereign  bond  markets  (in  particular 
liquidity), the implications of primary and/or secondary market sovereign bond purchases 
by SBBS issuers, and the possible regulatory treatment of SBBS. 

On sovereign bond market liquidity: DMOs stressed that liquidity and transparency on 
a  marketable  volume  of  debt  are  a  prerequisite  for  a  well-functioning  market.  Thus, 
SBBS would need to be issued in a sizeable amount (up to EUR 2 trillion) in order to be 
accepted  and  bought  by  investors.  This,  however,  could  have  a  negative  impact  on  the 
remaining  national  sovereign  debt  markets  (reducing  liquidity,  increasing  refinancing 
costs, in particular for small and medium sized sovereign debt markets).  

On  primary  and  secondary  market  purchases  by  the  SBBS  issuer:  The  HLTF 
considered both secondary and primary market purchases (including dedicated issuances) 
as  ways  for  SBBS  issuers  to  build  their  underlying  sovereign  bond  portfolios.  DMOs 
stated  that  either  option  would  cause  problems  for  sovereign  issuers,  as  they  would 
disrupt  market  functioning.  Further,  both  options  would  require  a  risk-taking  treasury 
function  for  SBBS  issuers,  which—in  case  of  a  public  issuer—could  give  rise  to 
mutualisation  of  risks.  Regarding  the  proposal  for  dedicated  issuances,  DMOs  stressed 
that  it  would  violate  their  legal  obligations  not  to  offer  preferential  access  and  would 
have a negative impact on the functioning of sovereign debt markets, notably on market 
access, debt rollover in each country, and price formation disruptions.  

On  the  regulatory  treatment  of  SBBS:  DMOs  highlighted  that  any  regulatory 
intervention  should  not  include  privileges  for  SBBS  compared  to  the  underlying 
sovereign  bonds,  as  this  would  lead  to  higher  funding  costs  for  sovereigns.  They 
questioned whether, without regulatory privileges SBBS could ever become viable.  

68 

 
 
ANNEX 3 

WHO IS AFFECTED AND HOW? 

1.  PRACTICAL IMPLICATIONS OF THE INITIATIVE 

This annex assesses the different impacts of the identified policy options (models) on the 
main stakeholders, as well as on the aggregate financial sector. The key stakeholders that 
would  be  affected  by  the  proposed  legislation  include  banks  (and  other  financial 
institutions  subject  to  CRR/CRD),  other  asset  managers,  the  arrangers/issuers  of  the 
product,  supervisors,  and  debt  management  officers  (as  proxies  for  the  effect  of  the 
legislation and of SBBS on the national sovereign debt markets).  

The impact, both in terms of potential benefits and potential costs, would depend on the 
size  ultimately  achieved  by  the  market.  Since  the  proposed  intervention  is  an  enabling 
legislation,  and  considering  that  the  product  to  be  enabled  does  not  currently  exist, 
whether or not the market for such product will take off or to what extent is difficult to 
predict  with  certainty.  Nevertheless  some  general considerations  can  be  offered  to  help 
gauge  the legislation's possible ultimate impacts,  and the channels  through which these 
would come about. The general costs and benefits, irrespective of the specific option or 
scenario  considered,  are  summarised  in  Table 5  and  Table 6,  respectively.  Table 7  and 
Table 8 summarise the possible impact more specifically per stakeholder and respectively 
for a scenario in which the enabled product reaches only a limited size, and one in which 
instead  the  product  reaches  a  macro-economically  significant  size  (steady  state 
scenario)51.  Lastly,  Table 9  focusses  specifically  on 
the  compliance  costs  for 
stakeholders.  

51 For example, either EUR 500 billion, which the HLTF report currently envisages could be reached within 10 
years, or EUR 1,500 billion, which the HLTF considers as the steady state size of the market, taking into 
account constraints which are necessary to safeguard market functioning and price formation. 

69 

 
                                                      
Table 5: Overview of the benefits  

I. Overview of Benefits (total for all provisions) 

Description 

Amount 

Comments 

Eliminated 
regulatory 
surcharges 

#NA. 

A new product 
becomes available 

#NA. 

A more stable 
financial system 

#NA.  

#NA.  

Expand the 
investor base for 
European 
sovereign debt  

#NA. 

Indirect benefits 
on retail investors, 
households or 
SMEs 

Direct benefits 

Capital requirements: At present, holding SBBS would be 
associated with positive capital requirements. The proposed 
legislation would either completely eliminate these (models 1 and 
5) or eliminate them for senior tranches (model 2). 
Liquidity coverage requirements: banks would be able use these 
new products to meet liquidity coverage requirements, which is 
not possible under the current regulatory framework.  
These benefits would increase with the market size of the new 
instrument. Some indicative calculations to gauge the economic 
significance of these benefits are provided in Annex 4.   

A new instrument would become available for banks, insurance 
companies, pension funds and other investors. Two scenarios 
have been analysed. A "limited" scenario, in which SBBS 
develop very gradually and reach a limited volume 
(EUR 100 billion) and a "steady state" one where SBBS reach a 
macroeconomically significant volume (EUR 1,500 billion).  
The actual size of the SBBS market will depend on the 
instruments' overall attractiveness for market participants. 

A quantitative assessment is difficult, because of the significant 
uncertainty on the extent to which the market would develop.  
Nevertheless, from a qualitative perspective, the new instrument 
could contribute to financial system stability at large as it would 
weaken the bank-sovereign loop. Further, as a share of the 
outstanding sovereign bonds would be held in SBBS portfolios, 
these bonds would not be quickly sold off in times of financial 
market stress. 

A quantitative assessment is difficult, because of the significant 
uncertainty on the extent to which the market would develop.  
Nevertheless, from a qualitative perspective, benefits could be 
large. In particular for smaller Member States whose sovereign 
bonds may not be on the radar screen of investors, demand 
coming from the SBBS issuer would facilitate Debt Management 
Offices debt placements.  

Indirect benefits 

These sectors do not benefit directly as they are unlikely to be 
active in the SBBS market. They might benefit indirectly – 
including from enhanced confidence and lower borrowing costs – 
to the extent that the above-mentioned benefits in terms of 
enhanced financial stability materialise. 

70 

 
Table 6: Overview of the costs 

II. Overview of costs 

Citizens/Consumers  

Businesses 

Administrations 

One-off 

Recurrent 

One-off 

Recurrent 

One-off 

Recurrent 

None for 
SMEs and 
other Non-
Financial 
Corporations 

None for 
SMEs and 
other Non-
Financial 
Corporations 

For issuers of 
the new 
product, see 
Table 9 

For issuers of 
the new 
product, see 
Table 9  

Creation of 
a new 
legislation 

Supervision 
of SBBS 
(depending 
on the 
model, these 
costs range 
between 
limited and 
moderate) 

None 

None 

None 

None 

Direct 
costs 

None 

None 

Indirect 
costs 

None 

For all 
considered 
models   

If the 
introduction of 
SBBS were to 
impact sovereign 
bond market 
liquidity, this 
could lead to 
higher financing 
costs for Debt 
Management 
Offices, which 
would in the end 
be carried by the 
tax-payer. The 
analysis 
conducted by the 
HLTF suggests 
that any such 
costs would be 
limited (see also 
Annex 4.3) 

In  general  terms,  the  enabled  product  would  entail  the  following  benefits:  eliminate 
unjustified regulatory surcharges which allows for the development of a market of a new 
instrument,  lead  to  a  more  stable  financial  system  and  expand  the  investor  base  for 
national sovereign bonds (see Table 5). On the contrary, the costs for citizens, businesses 
and administrations appear to be limited (see Table 6). 

More  specifically  (see  Table 7  and  Table 8),  as  regards  banks  and  other  financial 
institutions subject to CRR/CRD, under all models the proposed legislation would have a 
positive (or, in the limit, neutral) impact in both scenarios. The legislation could unlock 
the  assembling  and  use  of  new  financial  products,  all  of  which  could—to  varying 
degree—potentially be used by banks to enhance their risk management.52 With the first 
two  models,  which  would  ensure  greater  standardisation  in  these  new  markets,  banks 
may have greater incentives to invest, because the new products would have many of the 
features of the benchmark government bonds that banks currently invest in, at least from 

52 See Annex 4, section 5 for some calculations on the impact of the introduction of SBBS on banks' sovereign 

portfolios under both the limited volume scenario and the steady state scenario. 

71 

 
 
                                                      
a  regulatory  perspective.53  Model 1  is  the  most  favourable  for  the  banks  (under  both 
scenarios), because besides gaining access to a potentially liquid product, they would be 
able to invest in all of its tranches without facing additional capital charges or liquidity 
discounts.54 In contrast, with model 2, banks would have an incentive to buy only senior 
tranches.55  

As regards the issuers/arrangers, under all models the proposed legislation would have a 
positive (or, in the limit, neutral) impact in both scenarios. The impact overall crucially 
depends  on  whether  the  product  would  be  profitable  to  arrange  or  not.  Again,  model 1 
seems to be the most favourable for arrangers in both scenarios. 

When it comes to the supervisors the impact under the different policy options crucially 
depends on the market infrastructure. It is impossible to predict the impact ex ante. While 
the  impact  would  be  positive  if  the  product  enhances  stability  of  the  overall  financial 
system through more diversified banks (most likely under models 1 and 2), some policy 
options  might  increase  the  costs  for  supervisors  given  the  non-standardisation  and 
different regulatory treatment of the tranches (e.g. model 4). 

The  impact  on  DMO's  depends  mainly  on  the  market  size  of  the  new  product  (limited 
volume scenario vs steady state scenario; but also models 1/2 vs. models 3/4) and the size 
of  the  national  sovereign  bond  market.  Especially  Member  States  with  low  debt  levels 
might  be  affected  more  markedly.  Under  the  steady  state  scenario,  large  amounts  of 
SBBS would reduce the amounts of sovereign bonds floating on the market. This could, 
for  some  Member  States,  result in  lower  trading  and  lower  liquidity.  Under  the  limited 
volume scenario (any such negative impact would be limited.56 At the same time, the fact 
that national bonds are bound in the SBBS portfolio/basket, contributes to greater support 
in time of volatility, as bonds in the SBBBS structures/basket would not be sold off. To 
the extent that SBBS would make the overall financial system more resilient, they could 
also help lowering sovereign funding costs.  

Regarding  compliance  costs,  only  the  costs  associated  with  the  preferred  compliance 
setup (that is, option 3.1—self attestation) are assessed. Those are based on the following 
actions,  which  need  to  be  undertaken  by  different  stakeholders  for  the  issuance  and 
distribution of the new product (we consider in what follows only models 1,2 and 3, i.e. 
those  for  which  issuers  have  to  assemble  a  pre-determined  portfolio  of  euro  area 
sovereign bonds (in line with the ECB key): 

Action 1: Debt issuance by DMO 

53 For example, in models 1 and 3, all tranches would be made fully eligible for liquidity-related requirements—
even though as new products the extent to which they would be liquid in practice is unknown a priori.  
54 Depending on the demand for bank loans, the extent to which any investment into these tranches would be an 
addition to a bank's existing sovereign portfolio or rather a reshuffling of the latter may vary. For example, if 
demand (and profitability) of bank loans is strong, so that investment in low-risk but also low-yielding assets 
such as sovereign bonds is minimized (and possibly strictly dictated by regulatory requirements), it is likely 
that banks would switch their existing sovereign portfolios into these new products, if they purchase the latter 
at all. In contrast, in a situation where banks have excess liquidity, it is possible that they might decide to add 
to their existing sovereign exposures via these new products. 

55 The same logic applies to models 3 and 4. 
56 See Annex 4, section 3 for an analysis of the impact of SBBS on national sovereign bond markets, in particular 

liquidity.  

72 

 
                                                      
Action 2: Structuration of the product by Arranger (purchase of underlying sovereign 
bonds, drafting of legal documentation for the transaction (including, where relevant, 
the tranching method and the payment waterfall), issuance of self-attestation) 

Action 3: Potential certification (non-mandatory) by Third party 

Action 4: Distribution of the SBBS by  Arranger on the basis of self-attestation and 
potential certification by third party 

Action 5: Due diligence carried out by Investors to check the product is compliant 

Action 6: Supervisory oversight of regulated investors by Supervisors 

It is to be noted that those actions are not necessarily taken in a chronological order, since 
for  instance  the  pre-marketing  and  book  building  of  the  product  can  start  before  the 
underlying  sovereign  bonds  are  issued.  Similarly,  distribution  arrangements/agreements 
can  be  entered  into  before  the  Arranger  puts  together  the  relevant  portfolio  (and  issues 
the tranches, if relevant). 

2.  SUMMARY OF COSTS AND BENEFITS 

Table 5  and  Table 6  summarise  the  costs  and  benefits  in  general  terms.  Table 7  and 
Table 8 sketch out a summary of the costs and benefits of the five models on for different 
stakeholders,  first  for  a  limited  development  of  the  product  and  second  for  the  steady 
state  where  the  product  reaches  a  macroeconomically  significant  size.  Table 9  focusses 
on the compliance costs for stakeholders, on the basis of the actions describe above. 

73 

 
Table 7: Impact Assessment Analysis, by Stakeholder Type (limited volume scenario) 

Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product 
achieves only a limited size. 

74 

Model 1Model 2Model 3Model 4Model 5Only SBBS proper;Treat all tranches as euro area sovereign bondsOnly SBBS proper;Treat only Senior  tranches as euro area sovereign bondsAll securitisations;Treat all tranches as euro area sovereign bondsAll securitisations;Treat only Senior  tranches as euro area sovereign bondsProper SBBS basket;Treat basket as euro area sovereign bondsBanksPositive. New products become available, with minimised regulatory charges. Positive. New products become available, with minimised regulatory charges. Banks would face high charges if they invest in sub-senior tranches. This may, however, lead them to de-risk.Positive/Neutral. Access to more products. But products may not be attractive if not liquid/standardised.Positive/Neutral. New products become available, some with reduced/no regulatory charges. But products may not be attractive if not liquid/standardised.Neutral. Access to a new standsardised product. But product may not be attractive from a risk-return perspective and assets based on the basked would be riskier than the current portfolios of most banks.Other investorsPositive/Neutral. Some new products become available, which may have benchmark-like properties.Positive/Neutral. Some new products become available, which may have benchmark-like properties.Positive/Neutral. New products become available, with minimised/no regulatory charges. But products may not be attractive if not liquid/standardised.Positive/Neutral. New products become available, with minimised/no regulatory charges. But products may not be attractive if not liquid/standardised.Neutral. Access to a new standsardised product. But product may not be attractive from a risk-return perspective.ArrangersPossibly positive. A market may develop out of standardisation, with no regulatory disincentives, and it would have to be profitable for the product to be viable (though competition among potential issuers could bring any rent down to zero).Possibly positive. A market may develop out of standardisation, with no regulatory disincentives, and it would have to be profitable for the product to be viable (though competition among potential issuers could bring any rent down to zero). More challenging than model 1 because the potential investor base for sub-senior tranches is more restricted.Neutral. Little structure means maximum flexibility. But market may not develop for lack of standardisation → not profitable.Neutral. Little structure means maximum flexibility. But market may not develop for lack of standardisation → not profitable. Moreover finding buyers for sub-senior tranche may be more challenging.Neutral. A market may develop out of standardisation, but it would have to be profitable for the product to be viable.SupervisorsDepends on market infrastructure, but positive if financial system is overall more stable.Depends on market infrastructure, but positive if financial system is overall more stable.Depends on market infrastructure.Depends on market infrastructure. May be more costly to monitor/enforce than model 3.Depends on market infrastructure.DMOsUnclear. Some products could compete with some sovereign bonds. But effects likely to be small if market is small.Unclear. Some products could compete with some sovereign bonds. But effects likely to be small if market is small.Unclear. Some products could compete with some sovereign bonds. But effects likely to be small if market is small.Unclear. Some products could compete with some sovereign bonds. But effects likely to be small if market is small.Unclear. Product could compete with some sovereign bonds. But effects likely to be small if market is small. 
 
Table 8: Impact Assessment Analysis, by Stakeholder Type (steady state scenario) 

Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product 
reaches a macro-economically significant size. 

75 

Model 1Model 2Model 3Model 4Model 5Only SBBS proper;Treat all tranches as euro area sovereign bondsOnly SBBS proper;Treat only Senior  tranches as euro area sovereign bondsAll securitisations;Treat all tranches as euro area sovereign bondsAll securitisations;Treat only Senior  tranches as euro area sovereign bondsProper SBBS basket;Treat basket as euro area sovereign bondsBanksVery positiveAdditional benchmark-type products are now available at no/low regulatory charges. The senior tranche, being low risk, can be quite effective at isolating banks from idiosynchratic gyrations in the price of individual euro area sovereign bonds.Very positiveAdditional benchmark-type products are now available at no/low regulatory charges. The senior tranche, being low risk, can be quite effective at isolating banks from idiosynchratic gyrations in the price of individual euro area sovereign bonds. Banks would face charges if they held sub-senior tranches. But this may lead them to de-risk.Positive/Neutral. Access to more products. But products may not be attractive if not liquid/standardised.Positive/Neutral. New products become available, some with reduced/no regulatory charges. But products may not be attractive if not liquid/standardised.Neutral.Access to a new standsardised product with no regulatory charges. But product may not be attractive from a risk-return perspective and assets based on the basked would be riskier than the current portfolios of most banks.Other investorsPositive. Additional benchmark-type products are now available, offering different risk-return profiles which may cater to different clientelesPositive. Additional benchmark-type products are now available, offering different risk-return profiles which may cater to different clientelesPositive/Neutral. New products become available, with minimized/no regulatory charges. But products may not be attractive if not liquid/standardisedPositive/Neutral. New products become available, with minimized/no regulatory charges. But products may not be attractive if not liquid/standardisedNeutral. Access to a new standsardised product. But product may not be attractive from a risk-return perspective.ArrangersPositive. A new market is now available, evidently profitable (though competition among potential issuers would bring any rent down to zero). The new product may attract demand which is additional with respect to the demand of underlying bonds. Hence the overall size of the industry (e.g., primary dealers) may be boosted.Positive. A new market is now available, evidently profitable (though competition among potential issuers would bring any rent down to zero). The new product may attract demand which is additional with respect to the demand of underlying bonds. Hence the overall size of the industry (e.g., primary dealers) may be boosted. More challenging than model 1 because the potential investor base for sub-senior tranches is more restricted.Positive if the market development is all on one or a few products only, which then become attractive/profitable thanks to standardisation. Otherwise, neutral. Positive if the market development is all on one or a few products only, which then become attractive/profitable thanks to standardisation. Otherwise, neutral. Investor base for large quantities of sub-senior tranches may be more challenging than under model 3.Neutral. A market may develop out of standardisation, but it would have to be profitable for the product to be viable.SupervisorsPositive. Banks are likely to be more diversified, which makes the financial system more stable. This is likely to outweigh any costs from ad-hoc supervision/certification/licensing duties.Positive. Banks are likely to be more diversified and to have carved out the most volatile exposures, which makes the financial system more stable. This is likely to outweigh any costs from ad-hoc supervision/certification/licensing duties.Depends on market infrastructure and on the extent to which the new products are used by financial sector players, and banks in particular, to effectively reduce risks.Depends on market infrastructure and on the extent to which the new products are used by financial sector players, and banks in particular, to effectively reduce risks. Monitoring/enforcing costs are likely to be greater than in model 3 but so is also the de-risking potential fior banks.Depends on market infrastructure. 
 
 
Table 8 (continued): 

Note: this table characterises the main impacts on the key stakeholders in a scenario in which the enabled product 
reaches a macro-economically significant size in the steady state. 

76 

Model 1Model 2Model 3Model 4Model 5Only SBBS proper;Treat all tranches as euro area sovereign bondsOnly SBBS proper;Treat only Senior  tranches as euro area sovereign bondsAll securitisations;Treat all tranches as euro area sovereign bondsAll securitisations;Treat only Senior  tranches as euro area sovereign bondsProper SBBS basket;Treat basket as euro area sovereign bondsDMOsUnclear. To the extent that SBBS render the financial system more resilient (e.g., weaken bank-sovereign loop), they could help lower sovereign funding costs. Large amounts of SBBS would reduce the amounts of sovereign bonds floating on the market. In some cases (e.g., especially for Member States with relatively low debt) this could result in reduced trading/liquidity. This would need to be juxtapposed to any benefit from greater support in time of volatility, since bonds in SBBS structures would not be sold off. Unclear. To the extent that SBBS render the financial system more resilient (e.g., weaken bank-sovereign loop), they could help lower sovereign funding costs. Big volumes of SBBS would reduce the amounts of sovereign bonds floating on the market. In some cases (e.g., esp. for Member States with relatively low debt) this could lead to reduced trading/liquidity. This would need to be juxtapposed to any benefit from greater support in time of volatility (bonds in SBBS structures would not be sold off). The effect of greater banks' incentives to offload junior tranches depends on the elasticity of demand for senior tranches by banks and for all tranches by other investors.Unclear a priori. "Successful" products could compete with some sovereign bonds. And, depending on what these successful products bundle together, the liquidity on some sovereign debt market could be affected. The extent to which funding costs are lowered from reduced "doom loop" risk is difficult to assess a priori.Unclear a priori. "Successful" products could compete with some sovereign bonds. And, depending on what these successful products bundle together, the liquidity on some sovereign debt market could be affected. The extent to which funding costs are lowered from reduced "doom loop" risk is difficult to assess a priori. The effect of greater banks' incentives to offload junior tranches would depend on the elasticity of demand for senior tranches by banks and for all tranches by other investors.Unclear. The proper SBBS basket could compete with some sovereign bonds. Large amounts of proper SBBS baskets would reduce the amounts of sovereign bonds floating on the market. In some cases (e.g., especially for Member States with relatively low debt) this could result in reduced trading/liquidity. This would need to be juxtapposed to any benefit from greater support in time of volatility, since bonds in the SBBS basket structure would not be sold off.  
 
 
 
Table 9: Overview of compliance costs, option 3.1 

DMO 

Arranger 

Investor 

Supervisor 

Third party validators 

- 

No compliance costs 
are expected for 
DMOs compare to the 
baseline scenario 

A
c
t
i
o
n
(
1
)

Some costs could 
arise if DMOs have to 
increase the 
coordination of their 
issuance activities 
(e.g., issue similar 
maturities at similar 
times). Such 
coordination is not 
necessary, however, 
and would 
presumably be 
undertaken only if 
deemed worthwhile.  

- 

A
c
t
i
o
n
(
2
)

- 

A
c
t
i
o
n
(
3
)

Compliance relies on 
arranger, however 
the self-attestation 
does not entail any 
administrative 
burden compared to 
the structuration of 
other products. The 
ESRB HLTF 
estimates upfront 
costs of 
EUR 1.15 million 
and annual costs of 
EUR 3.26 million 
for an SBBS 
programme of 
EUR 6 billion (see 
ESRB HLTF report, 
section 4.1.2) 

- 

- 

- 

- 

- 

- 

- 

- 

Such costs would 
ultimately need to be 
borne by investors; 
however since the 
mechanism is not 
mandatory, this would 
not in any event 
undermine the viability 
of the product. In 
addition, and as 
explained in greater 
detail in section 6.4, 
these costs are likely to 
be small, given the 
limited nature of the 
certification/review. 

77 

The compliance costs 
associated with non-
mandatory third party 
certification would 
depend on the level of 
competition on this 
market. These costs 
are likely to be small, 
given the limited 
nature of the 
certification/review 
(basically, confirming 
that the stated 
sovereign bonds are 
effectively in the 
underlying portfolio 
and in the stated 
quantities).  

 
 
 
 
 
 
 
 
 
 
 
 
 
 
- 

- 

A
c
t
i
o
n
(
4
)

A
c
t
i
o
n
(
5
)

A
c
t
i
o
n
(
6
)

- 

- 

- 

- 

- 

No additional cost 
compared to the 
distribution of other 
structured products 

- 

No administrative cost 
is required from 
investors; regulated 
investors will however 
need to ensure the 
product purchased 
complies with 
regulatory 
requirements; this is 
however inherent to 
the activities of 
regulated investors and 
likely to be relatively 
inexpensive, given the 
pre-determined 
structure of the product 
and the fact that it 
hinges on euro-area 
sovereign bonds. 

Supervisors will 
perform their controls 
as for any other assets 
held by regulated 
investors. This does 
not entail additional 
costs compared to the 
baseline scenario 

The preferred setup for ensuring compliance (option 3.1) does not entail any additional 
cost  compared  to  the  regular  conduct  of  business.  The  only  potential  compliance  costs 
may arise from the recourse to a voluntary certification by an independent third party, in 
which  case  the  costs  would  be  ultimately  borne  by  investors.  Those  costs  remain 
hypothetical, and their quantification would depend on a wide range of factors, such as 
the market structure for such business. They are likely to be small, given the limited nature of 
the  certification/review  (basically,  confirming  that  the  stated  sovereign  bonds  are  effectively  in 
the  underlying  portfolio  and  in  the  stated  quantities).  The  voluntary  recourse  to  such 
mechanism ensures that it would not undermine the viability of the SBBS. 

78 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ANNEX 4 

ANALYTICAL METHODS 

This  annex  covers  analytical  assessments  to  provide  evidence  on  (1)  the  extent  of 
"hindrance" faced by SBBS at present (pre-1/1/2019); (2) the extent of "hindrance" faced 
by  SBBS  at  post  1/1/2019;  (3)  the  extent  to  which  SBBS  would  impact  remaining 
national debt markets; (4) an estimation of the impact on the volume of AAA assets; and 
(5) and estimation of the impact on the composition of banks' sovereign portfolios. 

1.  EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT PRESENT 

This  annex  is  based  on  the  assessment  undertaken  by  the  ESRB  HLTF,  presented  in 
section 5.5  in  volume II  of  the  report  and  focuses  on  evidence  on  the  extent  of 
"regulatory hindrance" faced by SBBS under current regulations (pre-1/1/2019).  

The  analysis  compares  the  impact  on  banks'  and  insurance  companies'  capital 
requirements57 if existing sovereign exposures were replaced by senior SBBS under the 
current regulatory regime.58  

Analysis for banks 

It compares two scenarios: 

-  Scenario 1 – status quo: SBBS do not exist, and banks hold their existing sovereign 
bond portfolios. This is the status quo benchmark against which the alternative with 
SBBS is measured. 

-  Scenario 2  –  banks  replace  their  entire  sovereign  bond  portfolios  by  senior  SBBS 
under current regulatory treatment. Banks’ SBBS holdings are treated according to 
current  securitisation  regulations  (Articles  242-270  of  the  CRR)  and  receive  a risk 
weight  of  20%  for  credit  risk.  The  look-through  approach  would  apply  for  the 
concentration risk charge. This means that the share of each sovereign in the SBBS 
(multiplied by the total holdings that are exchanged for SBBS) would be set against 
the bank’s Tier 1 capital to determine whether and in which concentration bucket the 
exposure to that sovereign would fall. In the case of partial substitution, this amount 
would have to be added to the remaining sovereign holdings of each sovereign.  

The data used comes from the EBA 2015 Transparency Exercise for end-June 2015 and 
includes 105 EU banks at the highest level of consolidation. The data includes exposures 
to  central  government,  regional  government  and  local  authorities.  The  composition  of 
SBBS is assumed to include only euro area sovereign bonds. Further, it is assumed that 
senior SBBS obtain a rating within credit quality step 1.  

As  an  illustrative  exercise,  banks  are  assumed  to  exchange  their  entire  portfolio  of 
sovereign  holdings  for  senior  SBBS.  This  exercise  thus  generates  an  upper  bound 
estimate of the additional capital requirements to which SBBS are subject in the current 

57 As regards liquidity coverage requirements, banks would be able use SBBS to meet liquidity coverage 

requirements, which is not possible under the current regulatory framework. This would thus constitute a 
benefit which would increase with the volume of the new instrument. 

58 The analysis of the ESRB HLTF is much wider and covers the impact on capital requirements under different 

possible RTSE reform options. 

79 

 
                                                      
regulatory  framework,  as  less  comprehensive  switches  would  be  associated  with  lower 
associated  capital  requirements.59  The  results  are  presented  in  Table 10.  They  clearly 
show that the status quo would lead to a higher cost of holding SBBS versus holding the 
underlying directly, given SBBS would have a high credit risk weight of 20% for senior 
SBBS  under  current  regulation  (Scenario 2).  This  treatment  to  which  they  would  be 
subject under existing regulation reveals a key reason for the non-existence of SBBS.  

Table 10: Capital charges for euro area sovereign exposures or senior SBBS under the two 
scenarios (assuming 100% substitution) 
Regulation of  
(the underlying) 
sovereign bonds  

Scenario 1 
(current sovereign bond holdings; no 
SBBS) 

Scenario 2 
(SBBS: current securitisation 
regulation, credit RW: 20%) 

EUR billion 

As a % of  
CET 1 capital 

EUR billion 

As a % of  
CET 1 capital 

Status quo  

0 

0 

70.7 

5.0 

Notes: Total capital needs refer to the capital banks would have to raise to keep their current CET1 capital ratio 
constant. 
Source: Report of the ESRB HLTF. 

Analysis for insurance companies 
A  similar  analysis  has  been  conducted  on  the  implications  for  insurance  companies60 
replacing  their  sovereign  holdings  with  senior  SBBS.  Table 11  shows  estimates  of  the 
absolute and relative increase in the Solvency Capital Requirement (SCR) for euro area 
solo  insurance  companies  if  they  were  to  reinvest  their  current  holdings  of  euro-
denominated  sovereign  bonds  into  senior  SBBS,  and  if  they  are  assumed  to  be  treated 
under current regulatory rules. These figures underline that under the existing regulatory 
treatment  insurance  companies  would  have  no  incentive  to  hold  SBBSs  compared  to 
sovereign bonds.  

Table 11: Increase in SCR requirements for euro area solo insurance companies 

Status quo: 
Treatment of 
sovereign bonds 

Scenario 1a: 
Treatment of senior SBBS as 
type 2 securitisation 

Scenario 1b: 
Treatment of senior SBBS as 
type 1 securitisation 

Increase in SCR 
(EUR billions) 

Relative increase in 
SCR (%) 

0 

0 

963 

262 

166 

45 

Notes: Type 1 securitisations are "high quality" securitisations, while all others are covered under type 2 
securitisations. 
Source: Report of the ESRB HLTF. 

59 At the same time, if banks were to switch not just into senior but also sub-senior SBBS tranches, the resulting 
capital requirements would actually be correspondingly larger, since sub-senior tranches under the current 
regulatory framework would warrant higher risk weights than senior ones. 

60 Euro area insurers hold assets of EUR 7.3 trillion. The current allocation of all euro area insurers to Euro 

sovereign bonds is EUR 1.500 billion. The average duration is 8.96 years. 

80 

 
 
 
 
                                                      
2.  EVIDENCE ON THE EXTENT OF "HINDRANCE" FACED BY SBBS AT POST 1/1/2019  

As  discussed  in  the  main  text,  even  after  the  entry  into  force  of  Regulation  (EU) 
2017/2042  on  1/1/2019,  banks  using  standardised  approach  for  the  determination  of 
capital  requirements  would  not  be  able  to  apply  a  full  look-through  (and  thus  benefit 
from zero risk weights) to sub-senior tranches of SBBS. 

To gauge the extent of this hindrance, albeit somewhat indirectly, we have calculated the 
proportion  of  sovereign  bonds  which  at  present  are  assessed  under  the  standardised 
approach. 

Using the granular data of the EBA 2017 transparency exercise as of 30 June 2017, we 
compare  for  each  bank  in  the  EBA  sample  (133  banks)  the  share  of  government  and 
central  bank  exposures  assessed  under  the  standard  method  and  the  IRB  method  for 
prudential  purpose.  We  then  calculate  the  amount  of  sovereign  bonds  hold  by  those 
banks which mainly use the standard method. 

The exercise shows that: 

  98 out of 133 banks mostly use the standard approach and would thus be subject to 
stiff  capital  requirements  if  they  switched  their  sovereign  holdings  into  the  three 
tranches. 

  Some  37%  of  all  sovereign  bonds  in  the  sample  are  currently  held  by  those  banks 

which mostly use the standardised approach. 

In  addition,  since  the  sample  of  the  EBA  includes  the  most  complex  banks  in  the  EU, 
which are also the most likely to use the IRB approach, our results remain conservative 
and tend to underestimate the overall use of the standard method by EU banks. 

Therefore the hindrance in the status quo would be rather significant. Indeed, assuming 
that banks fully switch their current holdings of sovereign bonds for balanced positions 
in  all  the  three  SBBS  tranches  (i.e.,  invest  respectively  70%  in  the  senior,  20%  in  the 
mezzanine and 10% in the junior) and assuming that the mezzanine (respectively, junior) 
tranche  would  attract  a  capital  charge  of  80%  (respectively  1250%),  equivalent  to  a 
quality step 4 (respectively, 17 or higher, including not rated) in the table of Article 264 
of  Regulation  (EU)  2017/2401  (rescaled  for  STS-like  securitisations),  aggregate  risk-
weighted capital would increase by about EUR 1,675 trillion.61 

Of  course,  this  is  an  upper  limit,  and  its  value  depends  on  the  assumptions  made 
(including  on  the  risk  weights  warranted  by  the  sub-senior  tranches).  A  more  limited 
switch,  for  example,  would  be  associated  with  correspondingly  lower  capital  charges: 
assuming  that  the  SBBS  market  reaches  EUR 100 billion,  as  in  the  limited  volume 
scenario  discussed  in  section  6.1  of  the  main  text,  and  that  SA  banks  would  buy  some 
EUR 62 billion of this amount (in line with their current shares of government bonds in 
the  overall  banking  book),  aggregate  risk-weighted  assets  would  increase  by  some 

61 To translate this figure into an estimate of the aggregate increase in capital requirements, an assumption is 

necessary on the aggregate (average) capital requirement ratio. For example, a capital requirement ratio of, 
say, 8 % would lead to an increase in aggregate capital requirements of EUR 134 billion. 

81 

 
                                                      
EUR 87 billion. For the steady state scenario in which SBBS reach a much larger scale 
(i.e., EUR 1,500 billion), the equivalent calculation yields an increase in aggregate risk-
weighted  assets  to  the  tune  of  EUR 1.3 trillion.  (SA)  Banks  could  also  decide  to  only 
switch  into  senior  tranches  (provided  some  other  investors  purchase  the  sub-senior 
tranches), in which case they would face no additional capital requirements. 

Even  these  large  amounts  are  much  reduced  relative  to  what  would  prevail  before  the 
coming  into  force  of  Regulation  (EU)  2017/2042  on  1/1/2019.  The  corresponding 
calculation  for  a  full  switch  (respectively,  a  switch  of  EUR100  billion)  would  yield 
additional  risk-weighted  assets  of  EUR 2,985 trillion  (respectively,  EUR155  billion). 
This larger amount reflects: (i) the fact that, in the status quo and before 1/1/2019, also 
IRB banks would face capital charges on their holdings of tranches; and (ii) that also the 
senior tranche would face a positive risk weight (assumed at 20% in this calculation). 

3.  PRESENTATION  OF  THE  ANALYSIS  BY  THE ESRB  LIQUIDITY  WORKING  GROUP  ON 
THE EFFECTS OF SBBS ON NATIONAL SOVEREIGN BOND MARKET LIQUIDITY 

This section of annex 4 presents the assessment undertaken by the ESRB HLTF, shown 
in  section 4.4  in  volume II  of  the  report  on  the  possible  impact  of  SBBS  on  sovereign 
bond market liquidity.  

Concerns were raised regarding the impact of SBBS on sovereign bond market liquidity. 
Given that one fraction of currently outstanding central government debt securities would 
be "frozen" into SBBS portfolios they would be unavailable for trading.62 The analysis in 
the  ESRB  report  derives  the  implications  of  SBBS  from  the  liquidity  impact  of  the 
Eurosystem's Public Sector Purchase Programme (PSPP).  

On the other hand, SBBS would represent new securities with liquidity of their own. In 
principle,  SBBS  could  have  properties  that  are  comparable  to  current  sovereign  bonds, 
including  high  liquidity  and  collateral  eligibility.  With  a  mature  SBBS  market,  such 
properties  could  have  positive  spillover  effects  with  respect  to  national  sovereign  debt 
markets. In this section these channels are referred to as the 'spillover effect' of SBBS.  

At  the  same  time,  SBBS  may  also  help  to  relieve  scarcity  of  low-risk  assets,  which  is 
perceived  by  some  market  participants.  German  sovereign  bonds  in  particular  appear 
scarce relative to demand, given the role of those bonds in acting as a benchmark asset 
for the entire euro area. However, with a higher supply of low-risk assets (senior SBBS), 
the  excess  demand  for  German  sovereign  bonds  may  be  smaller.  Using  SBBS  for  repo 
markets 
towards  smooth  market 
functioning: for every 26 units of German bonds retained by SBBS issuers, there would 
be 70 units of senior SBBS. 

instead  of  sovereign  bonds  would  contribute 

In the presence of both freezing effects and spillover effects, the net effect of SBBS on 
the  market  liquidity  of  national  sovereign  markets  is  prima  facie  ambiguous.  The 
liquidity  of  SBBS  and  sovereign  bond  markets  therefore  depends  on  their  relative  size 

62 This could be mitigated by allowing SBBS issuers to lend out the securities in reverse repos, as it is currently 
done under the Eurosystem's implementation of its Public Sector Purchase Programme (PSPP). This would 
however be at odds with the presumption that issuers would be mere pass-through vehicles. 

82 

 
                                                      
and the corresponding strength of the offsetting freezing and spillover effects. If spillover 
effects dominate, both SBBS and sovereign bond markets could be liquid. On the other 
hand,  if  freezing  effects  dominate,  there  would  be  a  trade-off  between  the  liquidity  of 
SBBS and that of sovereign bonds. Also, there is a clear trade-off as the extent to which 
SBBS may affect national sovereign debt markets depends on SBBS market size: a large 
SBBS  market  implies  adequate  liquidity  of  the  asset,  but  potentially  at  the  expense  of 
national  sovereign  debt  market  liquidity.  On  the  contrary,  a  small  SBBS  market  would 
have limited knock-on effects to national sovereign debt markets, but may consequently 
itself be illiquid.  

To shed  more light  on the expected net effect of SBBS on  market  liquidity, the rest  of 
this section examines the freezing and spillover effects in turn.  

Liquidity impact 

The  PSPP63  programme  is  analogous  to  SBBS  insofar  as  sovereign  bonds  are  removed 
from the secondary market but may be available for securities lending. It should however 
be  noted,  that  there  are  two  key  caveats  to  the  conceptual  analogy  between  PSPP  and 
SBBS: First, the analysis only holds if an SBBS market – and in particular a large SBBS 
market  –  develops  only  after  an  unwinding  of  PSPP,  as  both  measures  together  could 
have  an  impact  on  liquidity  of  sovereign  bond  markets  given  their  "freezing  effect". 
Second, the analogy between the two instruments is imperfect insofar as SBBS and PSPP 
entail  some  important  differences.  In  particular:  (1)  In  parallel  to  the  PSPP,  the 
Eurosystem  implements  a  securities  lending  facility  to  support  secondary  market 
liquidity by alleviating bond scarcity. (2) The PSPP is implemented in a market-neutral 
manner, including with respect to maturities (eligible maturities range from 1-30 years). 
However, in the early phase of the SBBS market, SBBS issuers might focus on certain 
points of the curve – most likely 5- and 10-year debt securities – in order to build liquid 
benchmarks  to  aid  price  discovery  and  facilitate  the  development  of  a  futures  market 
referenced to SBBS. (3) While SBBS issuers could buy the SBBS cover pool on both the 
secondary and the primary market, purchases  under the PSPP take place  exclusively in 
secondary markets. (4) Purchases under the PSPP take place in  a continuous manner to 
avoid excessive market disruption, while purchases of the SBBS cover pool would most 
likely  take  place  in  lumpy  batches,  corresponding  to  discrete  SBBS  issuance  dates. 
(5) An  SBBS  program  would  differ  from  the  PSPP  insofar  as  the  former  constitutes  a 
partial replacement of long-term bonds with different long-term bonds, while the PSPP is 
essentially a partial replacement of long-term bonds with broad money. This implies that 
SBBS could be a source of liquidity and hedging opportunities that would help dealers to 
provide market liquidity elsewhere. 

Nevertheless,  the  Eurosystem's  PSPP  represents  a  significant  “stress  test”  of  the  likely 
impact  of  SBBS  on  sovereign  bond  markets,  since  aggregate  PSPP  holdings  (as  of 

63 The Eurosystem’s public sector purchase programme (PSPP) was implemented from 2015. It entails purchases 
by the ECB and euro area national central banks of government debt securities and other eligible public 
sector securities from the euro area. Purchased securities are effectively “frozen” on the collective balance 
sheet of the Eurosystem, and are only available for use in securities financing transactions under the 
conditions of the securities lending facility. 

83 

 
                                                      
February 2017) amount to just under EUR 1.4 trillion, which is at the very upper range of 
likely SBBS market size in its early years.  

Sovereign  bond  market  liquidity  can  be  proxied  by  price-based  and  volume-based 
indicators. The analysis reports time variation in three liquidity indicators, two of which 
are  price-based  and  one  of  which  is  volume-based.  In  principle,  the  time  variation  in 
these  indicators  provides  suggestive  evidence  regarding  the  limited  impact  of  PSPP  on 
sovereign debt market liquidity.  

As  a  first  indicator  bid-ask  spreads  at  daily  frequency  from  January  2014  to  February 
2017  from  MTS  are  obtained.64  Figure 6  plots  these  bid-ask  spreads  over  time  by 
country. Visually, there is no apparent general level shift in bid-ask spreads following the 
commencement of PSPP purchases in March 2015, denoted by the vertical black line in 
the  figure.  Figure 7  plots  the  bid-ask  spread  against  the  fraction  of  outstanding  central 
debt  securities  held  by  the  Eurosystem  under  the  PSPP  to  shed  more  light  on  the 
relationship  between  bid-ask  spreads  and  the  PSPP.  Overall,  both  figures  do  not  show 
any  systematic  evidence  that  PSPP  holdings  are  associated  with  increases  in  bid-ask 
spreads. The only Member States where bid-ask spreads appear to increase somewhat are 
Germany and Austria. In particular for Germany65 this has to be considered with caution, 
given the relatively low turnover of German Bunds on the MTS platform.  

Figure 6: Normalised bid-ask spreads in bps over 

time 

Figure 7: Average best daily bid-ask spreads 
against the fraction of outstanding 
government debt securities held by the 
Eurosystem under the PSPP 

Source: Report of the ESRB HLTF; Data: MTS. 

Source: Report of the ESRB HLTF; Data: MTS. 

The  second  indicator  is  also  price  based  and  consists  of  a  proprietary  liquidity  index 
computed by Tradeweb66. Figure 8 shows Tradeweb's index plotted against time while in 

64 MTS is an interdealer platform, focussed on euro-denominated securities and serves as a backstop for dealers 
who are unable to manage their inventory through customer relationships. MTS bid-offer spreads therefore 
tend to be relatively static and wider than actual market spreads in the more liquid market segments. In the 
MTS dataset, bid-ask spreads are measured in basis points as the difference between the best bid and ask 
price posted on the domestic and European MTS platforms, normalised by the mid-price, and averaged over 
each trading day. Bids and asks are posted with respect to benchmark 10-year national sovereign bonds. 

65 This is consistent with the findings of Schlepper et al. (2017) regarding overall Bund scarcity.  
66 Tradeweb is a request-for-quote trading platform focused on the dealer-to-customer market segment. 

Differently to MTS data (where data are based on quotes) Tradeweb data are based on transaction prices, i.e. 
those generated by actual trades. Tradeweb’s index is intended to measure liquidity levels within specific 

84 

 
 
 
                                                      
 
Figure 9  it  is  plotted  against  the  fraction  of  outstanding  central  government  debt 
securities  held  by  the  Eurosystem  under  the  PSPP.  Despite  the  higher  volatility  in  the 
Tradeweb  index67,  there  is  no  systematic  upward  trend  in  Tradeweb’s  liquidity  index 
across countries. Nevertheless, in the case of some countries, there appears to be a slight 
worsening in the liquidity index at the beginning of 2017.68  

Figure 8: Tradeweb liquidity index over time 

Figure 9: Tradeweb liquidity index against the 

fraction of outstanding government debt 
securities held by the Eurosystem under 
the PSPP 

Source: Report of the ESRB HLTF; Data: Tradeweb. 

Source: Report of the ESRB HLTF; Data: Tradeweb. 

Figure 10: Tradeweb volume indicator 

Figure 11: Tradeweb volume indicator against the 
fraction of outstanding government debt 
securities held by the Eurosystem under 
the PSPP 

Source: Report of the ESRB HLTF; Data: Tradeweb. 

Source: Report of the ESRB HLTF; Data: Tradeweb. 

The  third  indicator  is  volume-based  and  computed  against  both  time  (Figure 10)  and 
against  the  fraction  of  outstanding  central  government  debt  securities  held  by  the 
Eurosystem  under  the  PSPP  (Figure 11).  The  variable  is  calculated  as  the  ratio  of  the 
day’s  notional  traded  volume  over  the  average  daily  notional  traded  volume  over  the 
preceding  90  days.  This  ratio  is  then  mapped  to  one  of  five  categories,  so  that  the 
Tradeweb  volume  indicator  is  a  categorical  variable,  which  can  take  the  value  of  any 

fixed income markets, based on transaction prices relative to the mid-price. The vertical lines refer to 
9 March 2015, the beginning of the PSPP. 

67 Tradeweb’s index is more volatile because it is based on trade sizes that are generally much smaller and 

variable in size than those on MTS, as they reflect customer requests-for-quotes from a smaller number of 
dealers. By contrast, the MTS platform is a transparent limit order market which is very competitive. 
68 The data sample ends early 2017. To fully assess this apparent development, it would be important to obtain 

more recent data over 2017, given that PSPP holdings have continued to increase. 

85 

 
 
 
 
 
 
                                                                                                                                                              
integer  between  1  and  5  inclusive,  where  1  corresponds  to  low  turnover  and  5  to  high 
turnover.69 Across countries, the average value of the volume indicator is 2.8 over 2014-
16,  suggesting  a  mild  reduction  in  volumes  traded.  However,  there  is  no  change  over 
time:  the  indicator  stands  at  2.8  in  2014,  2015  and  2016,  i.e.  before  and  after  the 
introduction  of  the  PSPP.  The  fourth  indicator  illustrates  the  effect  of  liquidity  via  the 
Hasbrouck  ratio.  This  is  the  ratio  of  the  logarithmic  daily  price  difference  over  total 
turnover.  Figure 12  plots  the  Hasbrouck  ratio  over  time  and  Figure 13  against  PSPP 
holdings.  Again,  this  indicator  is  in  line  with  the  findings  illustrated  in  the  previous 
figures: there is not an observable worsening of liquidity over the program. 

Figure 12: Hasbrouck ratio over time 

Figure 13: Hasbrouck ratio against the fraction of 
outstanding government debt securities 
held by the Eurosystem under the PSPP 

Source: Report of the ESRB HLTF; Data: Tradeweb. 

Source: Report of the ESRB HLTF; Data: Tradeweb. 

Lastly, a regression analysis is performed to provide a more rigorous assessment of the 
impact of PSPP on sovereign bond market liquidity. In particular, panel regressions are 
estimated, with normalised bid-ask spreads regressed on time and country fixed effects, 
as well as the magnitude of PSPP holdings.  

Coefficient 

Table 12: Results of fixed effects panel regression 

The  relationship  between  cumulative 
bond purchases and normalised bid-ask 
spreads  is  not  linear.  The  model  that 
best  describes  the  data  is  cubic  in 
nature. This means that normalised bid-
ask  spreads  (=dependent  variable)  are 
regressed  on  the  first,  second  and  third 
powers  of  cumulative  PSPP  purchases 
("pspp_cogovdebt", "pspp_cogovdebt2", "pspp_cgovdebt3"), as well as time and country 
fixed effects.70  

0.17423696 
Source: Report of the ESRB HLTF. 

Standard 
error 

pspp_cgovdebt3 

pspp_cgovdebt2 

pspp_cgovdebt 

0.00000273 

-0.0003711 

0.0000104 

0.0052111 

0.0024821 

0.0001223 

Constant 

0.00192 

P-value 

0.002 

0.007 

0 

0 

69 In particular, a value of 1 corresponds to ratio of less than or equal to 0.8, i.e. a “very low” turnover on that 
day relative to the preceding 90 days; a value of 2 corresponds to a ratio between 0.8 and 0.9, i.e. a “below 
average” turnover; a value of 3 corresponds to a ratio between 0.9 and 1.1, i.e. “average” turnover; a value of 
4 corresponds to a ratio between 1.1 and 1.2, i.e. “above average” turnover; and a value of 5 corresponds to a 
ratio of more than 1.2, i.e. “very high” turnover. 

70 The first three powers of the cumulative PSPP purchase, country and time dummies are the independent 

variables. 

86 

 
 
 
                                                      
 
 
The results of the panel regression (see Table 12) indicate that, controlling for unreported 
time and country fixed effects, the normalised bid-ask spreads are only slightly affected 
by  PSPP  purchases.  As  is  evident  from  the  table,  the  effect  of  the  programme  on 
normalised  bid-ask  spreads  is  statistically  significant,  yet  only  minor  in  terms  of 
economic magnitude, as the figure below reveals. 

Figure 14 plots  the predicted level of normalised bid-ask  spreads  for different levels of 
PSPP purchases using the results of the regression above. Specifically, the red line plots 
the forecasted normalised bid-ask spread of euro area sovereign bonds for different levels 
of  cumulative  PSPP  purchases71.  The  dots  depict  the  actual  normalised  bid-ask  spread 
observations for each country, net of the country and time fixed effects calculated in the 
panel regression.  

Figure 14: Actual vs fitted values of normalised bid-ask 
spreads net of country and time fixed effects, 
plotted against cumulative share of central 
government bond purchases under the PSPP 

It  is  clear  from  the  figure  that  the 
impact  of  the  PSPP  on  bid  ask 
spreads  is  low.  The  mean  share  of 
PSPP  purchases  in  February  2017, 
across  the  countries  in  the  sample, 
was  around  17%.  For  that  value, 
we can observe that the mean euro 
area  normalised  spreads  show  a 
very 
by 
approximately  3  basis  points.  As 
program  purchases  move  toward 
the 
the 
regression  model  predicts  a  small 
liquidity:  PSPP 
deterioration 
holdings  at 
is 
associated  with  around  6 basis  points  increase  in  spreads.  However,  only  3  countries 
surpassed the 20% mark by end of February 2017, and the red line extends to account for 
the highest observed share of central government bond purchases (Germany at 26%).  

in 
the  26%  mark 

Source: Report of the ESRB HLTF. 

limit  of  33%, 

increase, 

issuer 

small 

The  analysis  above  has  shown  that  the  impact  of  the  PSPP  on  sovereign  bond  market 
liquidity  was  limited.  Only  in  some  Member  States  normalised  bid-ask  spreads  show  a 
minor to mild increase.72 

71 The fitted values in the red line are a forecast of euro area aggregate normalised bid-ask spreads and are 
estimated using the coefficients in Table 12 on different values of cumulative PSPP purchases across 
countries for each month in the time series. 

72 Overall, these findings are consistent with those of Schneider, Lillo and Pelizzon (2016), who analyse 

sovereign bond market liquidity over 2015 (in the months immediately following the commencement of the 
PSPP). They find that five and 10-year Italian sovereign bonds remained liquid and stable over 2015, 
consistent with the stable bid-ask spreads plotted for Italy in Figure 6. However, they also find that 30-year 
Italian sovereign bonds turned illiquid over the same period, which is consistent with the view that PSPP 
may have somewhat larger effects on liquidity levels in already less liquid segments of the market. Similarly, 
using a high-frequency, transaction-level analysis of Bundesbank purchases of German bonds in the 
framework of the PSPP, Schlepper, Hofer, Riordan and Schrimpf (2017) find that the price impact of 
purchases was stronger when markets were less liquid. However, the exception to this generally benign 
finding is Germany, where PSPP purchases appear to have induced a temporary deterioration in market 
liquidity over short periods. In their analysis of PSPP purchases of German bunds, Schlepper et al (2017) 
find that bid-ask spreads widened for purchased securities, particularly when compared to non-eligible 

87 

 
                                                      
 
 
Spillover effects 
The  following  analysis  –  also  performed  by  the  ESRB  HLTF73  –  shows  that  given  the 
relative neutrality (as compared to the PSPP) with respect to duration74, positive spillover 
effects  may  arise  from  SBBS  owing  to  their  provision  of  (i)  collateral  services  and (ii) 
hedging opportunities, conditional on SBBS attaining adequate liquidity and a regulatory 
level  playing  field  for  SBBS.75  Overall,  assuming  regulation  does  not  penalise  netting 
excessively,  there  is  in  prospect  a  significant  improvement  in  trading  costs  across  all 
European sovereign debt markets if SBBS effectively become benchmark securities. 

(i)  Provision  of  collateral  services:  While  repo  markets  in  sovereign  bonds  are  well 
developed, this would not necessarily be the case for SBBS. Such an active repo market 
could  however  develop  over  time,  once  the  SBBS  market  increases  in  size  and  the 
necessary infrastructure has developed.  

(ii) Provision of hedging opportunities: If SBBS are adequately liquid, banks and other 
investors  could  use  an  SBBS  portfolio  to  hedge  short  or  long  positions  in  sovereign 
bonds. SBBS could serve as relatively low-cost hedging instruments with euro area wide 
characteristics, and would be particularly valuable to dealer banks that provide quotes in 
sovereign bond markets.  

For the subsequent assessment the following assumptions and data are used: 

- 

It is assumed that SBBS markets would be deeper and more liquid than smaller euro 
area sovereign bond markets. 

-  Estimated SBBS yields, based on an approach developed by Schönbucher (2003)76, 
are used to examine the effects of hedging. The yield estimation method relies on a 
simulated  default-triggering  mechanism  and  a  market-based  indicator  of  default 
probability  applied  to  the  underlying  securities.  Figure 15  shows  the  time  series 
behaviour  of  yields  on  SBBS  under  two  alternative  subordination  assumptions  (a) 
70:30 and b) 70:20:10) and of a selection of sovereign bond yields (c). All data used 
in  the  analysis  has  been  converted  to  price  and  then  daily  holding  period  returns, 
with an assumed duration of 9 years.  

-  Hedging  effectiveness  of  SBBS  is  assessed  by  measuring  the  magnitude  and 
stability  of  time-varying  correlations  between  single  SBBS  (portfolios)  and 
individual sovereign bonds.  

-  Correlations  are  measured  using  a  range  of  methodologies,  including  dynamic 

conditional correlating using CDD-GJR-GARCH(1,1) modelling. 

bonds, while market depth was somewhat reduced for purchased securities (up to EUR 1.6 million per 
EUR 100 million purchased), compared to non-purchased eligible bonds. 

73 See chapter 4.4.2 of volume II of the ESRB HLTF report.  
74 The PSPP provides liquidity to financial markets by swapping medium- and long-term debt securities for 
central bank reserves. By contrast, an SBBS programme would swap national debt securities for SBBS 
securities of identical duration.  

75 An example, where securitisation improves market quality more widely than seems plausible at first glance is 
the "to-be-announced" Agency Mortgage Backed Securities market in the US. An analysis concludes that the 
presence of the "to-be-announced" market has had widespread beneficial effects on liquidity even where 
mortgage pools are not cheapest to deliver on the "to-be-announced" contract (Gao et al. (2017).  

76 See section 1.4 of the ESRB HLTF report for details on the estimation of SBBS yields.  

88 

 
                                                                                                                                                              
-  Subsequently, diversification benefits are measured by comparing the variance of a 
portfolio  of  hedged  positions  (with  weights  based  on  debt  outstanding)  compared 
with  the  variances  in  the  component  markets.  The  hedge  selection  and  assessment 
follows closely the comprehensive approach of Bessler et al (2016).77  

The  results  of  the  hedging  effectiveness  are  presented  in  Table 13 – Table 15.  The 
effectiveness  for  each  hedge  is  assessed  by  comparing  (taking  the  ratio  of)  the  hedged 
and  unhedged  standard  deviation  of  returns  and  Values-at-Risk  (i.e.  the  average  of  the 
ratio of the 5% and 95% Value-at-Risk). The results show that in the pre-sovereign debt 
crisis  period  hedge  effectiveness  is  high  for  all  Member  States  (Table 13).  The  best 
hedges are highlighted in bold. In the case of the single hedge, it is the senior-SBBS that 
gives the best protection. In almost all cases of a combined hedge (2 tranches) provides 
some  marginal  improvement  in  hedge  effectiveness  compared  to  the  single  tranche 
hedge. In many cases the best overall hedge is achieved with a combination of the three 
SBBS  tranches,  but  this  might  not  be  worthwhile  from  a  cost  perspective.  Table 14 
shows  the  summary  statistics  for  hedged/unhedged  relative  risks  during  the  sovereign 
debt  crisis.  For  the  single  (senior)  tranche  hedge,  only  Germany  remains  well  hedged. 
Roughly half of the risk is avoided by single SBBS hedging for the case of Finland and 
the  Netherlands.  The  two  and  three  tranche  hedges  generally  lead  to  some  small  but 
significant  risk  reduction  for  most  sovereigns  compared  to  the  single  tranche  hedge. 
Table 15 shows the results for the post-crisis recovery period (07/2012-Q4/2016). Using 
composite  hedging  usually  reduces  the  risks  by  half  or  more,  with  the  exceptions  of 
Greece and Portugal.  

The daily return on the hedged and unhedged positions for the case of hedging with just 
the  senior  and  for  the  case  of  hedging  with  a  mixture  of  the  senior  and  the  mezzanine 
tranche are shown in Figure 16 – Figure 18. The figures show in general that hedging is 
very effective in the pre-sovereign debt crisis period in reducing the variance of returns 
(with some isolated exceptions). Hedging is not effective for high-risk sovereigns during 
the height of the sovereign debt crisis but effectiveness returns to some extent during the 
recovery. In general the combined hedge works better than the single hedge in the crises 
and  recovery  periods.  As  regards  particular  countries,  Figure 16  shows  that  hedging  is 
quite consistently effective for core countries (DE, FR and NL, and the same counts for 
AT  and  FI  which  are  not  displayed).  In  these  cases,  the  composite  hedge  seems  to 
eliminate  the  occasional  blips  present  in  the  single  hedge  case.  For  non-core  Member 
States  results  are  less  clear:  Figure 17  shows  the  cases  of  BE,  ES  and  IT  and  clearly 
reveals  how  idiosyncratic  the  effects  are  during  the  crisis.  It  is  interesting  that  the 
composite  hedge  (senior  and  mezzanine)  works  better  than  the  single  hedge  during  the 
crisis and recovery (apart from one particular day). This tends to improve further with the 
inclusion  of  the  junior  SBBS  as  a  hedge  instrument  (this  more  general  case  is  not 
displayed  in  the  figure  but  can  be  seen  from  the  tabulated  results  yet  to  be  discussed). 
Figure 18  shows  the  more  volatile  cases  of  GR,  IE  and  PT.  There  is  also  evidence  of 
hedge  ineffectiveness  during  the  crisis  with  improvement  only  obvious  during  the 
recovery for IE and PT. Again, the composite hedge is better than the single hedge during 
the  recovery  for  these  countries  and  is  particularly  good  in  protecting  from  the  more 

77 See section 4.4.2 of the ESRB HLTF report for further model details, used data and results.  

89 

 
                                                      
extreme  movements.  Although  hedging  is  often  ineffective  in  these  cases  one  has  to 
acknowledge that these are small markets and their idiosyncratic riskiness could easily be 
diversified as part of a cross-country portfolio. 

Figure 15: Estimated yields on SBBS and selected sovereigns (%) 

a) 70:30 SBBS Yields 

b) 70:20:10 SBBS Yields 

c) Yields of DE, IT, GR & PT 

Source: ESRB HLTF report. Note: Shaded area is euro area Sovereign Debt Crisis period (11/2009-08/2012). 

90 

 
 
 
 
 
 
Table 13: Hedge Effectiveness: Pre-Sovereign Debt Crisis 

Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to 
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged 
returns relative to the unhedged returns. 

91 

Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr AT(i) 0.38 0.39 0.65 0.33 0.3 0.5 0.28 AT(ii) 0.27 0.28 0.65 0.23 0.18 0.43 0.16           BE(i) 0.35 0.37 0.64 0.28 0.25 0.48 0.23 BE(ii) 0.29 0.3 0.63 0.24 0.2 0.42 0.17           DE(i) 0.21 0.22 0.68 0.16 0.16 0.54 0.13 DE(ii) 0.15 0.19 0.69 0.14 0.12 0.51 0.11           ES(i) 0.45 0.45 0.64 0.38 0.34 0.47 0.31 ES(ii) 0.38 0.39 0.64 0.31 0.27 0.42 0.25           FI(i) 0.3 0.31 0.65 0.28 0.25 0.54 0.24 FI(ii) 0.21 0.23 0.64 0.19 0.16 0.47 0.16           FR(i) 0.28 0.29 0.63 0.22 0.2 0.47 0.17 FR(ii) 0.24 0.25 0.63 0.19 0.16 0.41 0.12           GR(i) 0.64 0.67 0.73 0.54 0.49 0.51 0.45 GR(ii) 0.54 0.56 0.67 0.4 0.4 0.42 0.33           IE(i) 0.58 0.6 0.74 0.53 0.49 0.61 0.48 IE(ii) 0.34 0.38 0.67 0.3 0.28 0.48 0.28           IT(i) 0.5 0.53 0.65 0.37 0.35 0.41 0.28 IT(ii) 0.44 0.5 0.63 0.31 0.3 0.36 0.23           NL(i) 0.31 0.32 0.63 0.25 0.22 0.46 0.19 NL(ii) 0.23 0.25 0.64 0.2 0.17 0.42 0.14           PT(i) 0.5 0.52 0.66 0.41 0.37 0.46 0.33 PT(ii) 0.38 0.4 0.62 0.31 0.27 0.39 0.23   
 
 
Table 14: Hedge Effectiveness: Sovereign Debt Crisis 

Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to 
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged 
returns relative to the unhedged returns. 

92 

Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr AT(i) 0.76 0.89 1 0.68 0.84 1.04 0.74 AT(ii) 0.68 0.81 0.98 0.59 0.61 0.95 0.59           BE(i) 0.97 0.96 0.98 0.73 1.1 0.84 0.8 BE(ii) 0.98 0.98 1 0.73 0.9 0.83 0.71           DE(i) 0.32 1 1.07 0.28 0.33 1.04 0.29 DE(ii) 0.31 1.04 1.05 0.27 0.31 0.95 0.27           ES(i) 1.01 1.1 1.01 0.67 1.1 0.69 0.72 ES(ii) 0.97 1.15 1.05 0.71 0.87 0.66 0.65           FI(i) 0.48 0.93 1.03 0.48 0.51 1.06 0.53 FI(ii) 0.46 0.96 1.02 0.46 0.46 1.04 0.45           FR(i) 0.77 0.88 1 0.65 0.85 1 0.69 FR(ii) 0.7 0.88 1.02 0.62 0.68 1.02 0.62           GR(i) 1 1.01 1 1 0.85 0.85 0.83 GR(ii) 0.96 1.13 1.11 1.02 1.26 1.28 1.23           IE(i) 1.02 1.07 1.02 0.97 1.01 0.98 1.01 IE(ii) 0.99 1.06 1.03 0.95 0.92 0.93 0.94           IT(i) 1 1.1 1.01 0.56 1.18 0.61 0.63 IT(ii) 1.02 1.13 1.03 0.6 0.91 0.57 0.56           NL(i) 0.51 0.91 1.02 0.52 0.54 1.07 0.57 NL(ii) 0.47 0.94 1.05 0.48 0.48 1.03 0.49           PT(i) 1.01 1.05 1.01 0.99 1.01 0.98 1 PT(ii) 1.01 1.02 1.01 0.95 0.9 0.92 0.91   
 
 
Table 15: Hedge Effectiveness: Post-Sovereign Debt Crisis 

Source: ESRB HLTF report, Note: Rows(i) contain the ratio of the standard deviation of the hedged returns relative to 
the unhedged. Row(ii) contain the average of the ratio of the 95th and 5th quantiles of the distributions of the hedged 
returns relative to the unhedged returns. 

93 

Hedge = Snr Mezz Jnr Snr-Mezz Snr-Jnr Mezz-Jnr Snr-Mezz-Jnr AT(i) 0.55 0.78 1 0.53 0.51 0.9 0.51 AT(ii) 0.49 0.75 1 0.47 0.43 0.86 0.44           BE(i) 0.56 0.74 0.98 0.52 0.47 0.87 0.48 BE(ii) 0.5 0.72 0.97 0.47 0.43 0.85 0.43           DE(i) 0.27 0.87 1.04 0.26 0.27 0.92 0.25 DE(ii) 0.28 0.9 1.04 0.27 0.27 0.93 0.26           ES(i) 0.98 1.02 0.97 0.68 0.74 0.58 0.57 ES(ii) 0.96 0.94 0.96 0.71 0.72 0.59 0.57           FI(i) 0.48 0.84 1.01 0.47 0.45 0.91 0.45 FI(ii) 0.41 0.82 1.01 0.4 0.38 0.89 0.38           FR(i) 0.5 0.73 0.98 0.45 0.42 0.85 0.41 FR(ii) 0.46 0.72 0.98 0.44 0.39 0.84 0.39           GR(i) 1 1.07 1.07 0.92 0.92 1.02 0.92 GR(ii) 1.05 1.06 1.08 1.03 1.11 1.17 1.12           IE(i) 0.9 0.89 0.97 0.79 0.78 0.81 0.73 IE(ii) 0.86 0.83 0.95 0.71 0.72 0.77 0.65           IT(i) 0.97 1.01 0.96 0.59 0.72 0.5 0.47 IT(ii) 0.93 0.95 0.96 0.59 0.66 0.48 0.46           NL(i) 0.47 0.82 1.01 0.46 0.44 0.91 0.44 NL(ii) 0.4 0.82 1 0.39 0.36 0.89 0.35           PT(i) 1 1.02 1 0.87 0.85 0.79 0.79 PT(ii) 0.99 1.02 1 0.87 0.83 0.75 0.74   
 
 
Figure 16: Single & Composite Hedging (DE, FR, NL) – returns measured in bps (left axis) 

(a) DE: Single (senior) Hedge 

(b) DE: Composite (sen+mez) Hedge 

(c) FR: Single (senior) Hedge 

(d) FR: Composite (sen+mez) Hedge 

(e) NL: Single (senior) Hedge 

(f) NL: Composite (sen+mez) Hedge 

Source: ESRB HLTF report.  

94 

 
 
 
 
 
  
Figure 17: Single & Composite Hedging (BE, ES, IT) – returns measured in bps (left axis) 

(a) BE: Single (senior) Hedge 

        (b) BE: Composite (sen+mez) Hedge 

(c) ES: Single (senior) Hedge 

     (d) ES: Composite (sen+mez) Hedge 

(e) IT: Single (senior) Hedge 

      (f) IT: Composite (sen+mez) Hedge 

Source: ESRB HLTF report.  

95 

 
 
 
 
 
Figure 18: Single & Composite Hedging (GR, IE, PT) – returns measured in bps (left axis) 

     (a) GR: Single (senior) Hedge 

     (b) GR: Composite (sen+mez) Hedge 

(c) IE: Single (senior) Hedge 

       (d) IE: Composite (sen+mez) Hedge 

(e) PT: Single (senior) Hedge 

       (f) PT: Composite (sen+mez) Hedge 

Source: ESRB HLTF report.  

96 

 
 
 
 
 
 
 
 
4. 

IMPACT ON THE VOLUME OF AAA ASSETS 

An estimation of the impact of the introduction of SBBS on the volume of AAA assets 
available  in  the  euro  area  has  been  carried  out  to  compare  the  respective  benefits  of  a 
tranched  product  ('SBBS  proper',  i.e.  Models  1  and  2)  and  the  untranched  basket  (per 
Model 5). 

The  calculation  is  based  on  Eurostat  data  on  euro  area  central  government  debt  as  of 
December 201678,  as  well  as  Standard  &  Poor's  ratings  of  euro  area  sovereign 
governments on the same date79. 

The  composition  of  the  SBBS  portfolio  is  based  on  the  ECB  capital  key  for  each  euro 
area  government.  Two  scenario  are  considered:  a  scenario  where  SBBS  develop 
gradually and reach a limited volume only (Limited volume scenario), and a steady state 
scenario with significant volumes of SBBS. 

The  estimation  is  based  on  a  static  approach,  whereby  the  impact  of  the  SBBS 
introduction  is  assessed  against  the  volumes  of  central  government  debt  as  of  2016. 
While  this  approach  ignores  the  future  evolution  of  (i)  central  government  debt  stocks 
and (ii) euro area sovereign ratings over the forthcoming years, it nevertheless allows for 
a robust comparison of the expected effects of options 1.2 and 1.3. 

The  analysis  assumes  that  the  senior  tranche  of  the  'SBBS  proper'  will  be  granted  an 
AAA  rating,  while  an  untranched  basket  would  not.  The  results  are  displayed  in 
Table 16. 

Table 16: Impact of the SBBS on the volume of AAA assets in the euro area 

(% of EA government debt rated AAA)  Limited volume scenario  Steady state scenario 

SBBS proper (Models 1 and 2) 

Basket (Model 5) 
Source: European Commission 

+2% 

-2% 

+30% 

-25% 

As  shown  in  Table 16,  the  impact  is  negligible  in  the  limited  volume  scenario  (Year  5 
after  a  gradual  introduction),  while  in  the  steady  state  it  could  increase  the  amount  of 
euro area sovereign debt rated AAA by up to 30%, subject to the tranching of the SBBS 
product.  Indeed,  a  mere  basket  would  conversely  negatively  impact  the  amount  of  EA 
government debt rated AAA by 25% in the steady state scenario, since the basket is not 
expected to be rated AAA. 

78 Downloaded from Eurostat website on 21 December 2017 at 10:42. 
79 Downloaded from S&P website on 21 December 2017. 

97 

 
 
 
                                                      
5. 

IMPACT ON THE COMPOSITION OF BANKS' SOVEREIGN PORTFOLIOS 

The  impact  of  the  introduction  of  the  SBBS  on  banks'  sovereign  portfolios  has  been 
assessed  under  both  the  limited  volume  scenario  and  the  steady  state  scenario.  This 
calculation  does  not  assess  separately  the  SBBS  proper  from  the  basket,  since  the 
diversification effect is assumed to be similar. 

Using the data of the EBA transparency exercise as of 30 June 2017 and the latest ECB 
capital  key,  the  analysis  calculates,  for  each  bank  in  the  sample  (96  banks  of  the  euro 
area),  the  reduction  in  domestic  holdings  if  banks  decided  to  switch  some  of  their 
domestic holdings for new SBBS bonds. For sake of simplicity, it is assumed that each 
bank would switch a proportion of its euro area sovereign portfolio similar to the overall 
ratio  of  SBBS  relative  to  the  universe  of  euro  area  central  government  bonds,  in  each 
scenario.  It  is  also  assumed  that  banks  would  only  switch  domestic  government  bonds 
insofar as their weight in the bank's portfolio exceeds the capital key of that government 
(home bias). 

Table 17: Impact of the SBBS on the diversification of banks' sovereign portfolios 

(Reduction of domestic holdings in %)  Limited volume scenario 

Steady state scenario 

SBBS proper (Models 1 and 2) 
Source: European Commission 

-3% 

-34% 

Table 17  shows  that  the  impact  would  be  small  in  the  limited  volume  scenario,  but 
significant under the steady state scenario. Under those assumptions, the home bias in the 
sample of euro area banks covered by the EBA transparency exercise would be reduced 
by 42%. 

Using the same sample of bank and the same assumptions, the impact of the introduction 
of  SBBS  on  the  amount  of  AAA  assets  held  in  banks'  sovereign  portfolios  is  assessed. 
The analysis is carried out for three models: model 1, model 2 and model 5. It is assumed 
in model 2 that banks would only hold the senior tranche of the SBBS proper, while in 
model  1  they  would  hold  all  the  tranches.  The  junior  and  mezzanine  tranches  of  the 
SBBS  proper  (model  1  and  2)  as  well  as  the  basket  (model 5)  are  expected  to  be  rated 
below AAA. 

Table 18: Impact of the SBBS on the amount of AAA assets in banks' sovereign portfolios 

(share of sovereign holdings rated AAA in %) 

Actual  Model 1  Model 2  Model 5 

Limited volume scenario 

Steady state scenario  
Source: European Commission 

24% 

24% 

24% 

32% 

24% 

33% 

23% 

19% 

As reported in Table 18, the impact would be negligible in the limited volume scenario, 
and  noticeable  and  positive  in  the  steady  state  scenario  for  the  SBBS  proper  option 
(model  1  and  2),  while  it  would  be  negative  in  the  case  of  baskets  (since  the  share  of 
AAA sovereign assets would drop from 24% to 19%). 

98