Explanatory Memorandum to COM(2018)339 - Sovereign bond-backed securities - Main contents
Please note
This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2018)339 - Sovereign bond-backed securities. |
|---|---|
| source | COM(2018)339  |
| date | 24-05-2018 |
1. CONTEXTOFTHEPROPOSAL
• Reasons for and objectives of the proposal
This proposal aims to enable a market demand-led development of Sovereign Bond-Backed Securities (SBBSs), to support further integration and diversification within Europe's financial sector, leading to a stronger and more resilient Economic and Monetary Union. This initiative complements other elements of Banking Union and Capital Markets Union by enhancing integration, risk diversification and risk reduction in the financial system.
Since the global financial crisis and the euro area sovereign debt crisis, considerable progress has been achieved in stabilising the EU and euro area financial sector and creating the conditions for further integration, by implementing common robust prudential and resolution rules for financial institutions. This is, among others, due to reforms such as the Bank Recovery and Resolution Directive1, the creation of the Single Supervisory Mechanism2 and the Single Resolution Mechanism as well as the Capital Requirements Regulation.3 Nevertheless, a further integration and diversification of financial markets across national borders has significant potential to make Europe and its Economic and Monetary Union more resilient through better risk diversification and better shock absorption via capital markets. This is the objective of the Commission's efforts to deepen and integrate further Europe's capital markets in the context of the Capital Market Union. The euro-area banking sector in particular continues to be vulnerable to the sovereign-bank nexus, i.e. the strong two-way link between the creditworthiness of a government and that of the banks in its jurisdiction, which is in part due to banks' tendency to concentrate their sovereign bond portfolios in their own sovereign (so-called 'home bias'). The resulting potential for destabilising mutual contagion and financial instability became apparent during the euro-area sovereign debt crisis: deteriorating creditworthiness of a sovereign leads, via lower bond values, to balance sheet strains for banks in its jurisdiction; in turn, banks' woes put pressure on the government budget either directly ("bailout") or via, e.g., lower tax revenues from weakened credit and economic activity. Beyond these links to their own government, banks also remain strongly exposed to economic developments in their home country (due to insufficient cross-border diversification).
Moreover, despite an increase in overall public debt until recently in the wake of the global financial crisis, the supply of high-rated euro-denominated sovereign bonds, which act as 'safe assets' in the modern financial system, has declined. At the same time, banks' and other financial institutions' demand for such assets has increased, including because of new regulatory requirements to hold sufficient buffers of highly liquid assets (e.g., in terms of liquidity coverage ratios).
framework for the recovery and resolution of credit institutions and investment firms (OJ L 173,
12.6.2014, p. 190).
Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European
Central Bank concerning policies relating to the prudential supervision of credit institutions (OJ L 287,
29.10.2013, p. 63).
prudential requirements for credit institutions and investment firms and amending Regulation (EU) No
2
3
As part of the Commission's efforts to advance the Banking Union and deepen the Economic and Monetary Union, in line with the May 2017 Reflection Paper on the deepening of the Economic and Monetary Union, and as announced in the 2017 September Letter of Intent accompanying President Juncker's State of the Union Address, and the December 2017 EMU deepening package, this proposal aims at providing an enabling framework for a market-led development of Sovereign Bond-Backed Securities (SBBSs).
SBBSs would be created by the private sector. A private sector entity would assemble an underlying portfolio of sovereign bonds from the market and would subsequently transfer them to a legally separate, self-standing entity, specifically set up for the sole purpose of issuing to investors a series of securities representing claims on the proceeds from this underlying portfolio. The various securities issued would bear any losses from the underlying portfolio in a certain sequence (i.e., losses would accrue first to holders of sub-senior, or subordinated, securities and only after such securities have been completely wiped out would they also accrue to the holders of senior claims).
SBBSs would not rely on any risk sharing or fiscal mutualisation between Member States. Only private investors would share risks and possible losses. SBBSs are therefore very different from Eurobonds.
In mid-2016, the European Systemic Risk Board (ESRB) established a high-level task force (henceforth, the ESRB task force) to assess SBBSs' merits and feasibility. The ESRB task force comprised representatives from many Member States' central banks and financial supervisory authorities, as well as of European institutions (the European Central Bank and the European Commission) and agencies (the European Banking Authority and the European Insurance and Occupational Pensions Authority), public debt management officers and academics.
The ESRB task force concluded4 that a market for SBBSs can develop under certain conditions. Yet, whether or not SBBSs are viable can ultimately only be ascertained by putting them to a market test. This proposal paves the way for such a market test.
A key finding of the ESRB task force, corroborated also by interactions with market participants and other stakeholders, is that the current regulatory framework constitutes a significant hindrance to the development of SBBSs. Under the existing regulatory framework, SBBSs would be defined as securitisation products, and hence would be treated significantly less favourably than their underlying portfolio of euro area sovereign bonds (e.g., via higher capital requirements, limited/no eligibility for liquidity coverage and collateral, stricter investment limits for various investor classes, etc.). However, due to the nature of their underlying assets and their standardised and simple nature, SBBSs carry risks that are comparable to the underlying sovereign bonds rather than regular securitisations. For example, there is no asymmetry of information between the issuer of SBBSs securitisation and the final investors, because the underlying assets are well-known and traded on the market.
It is therefore necessary that the regulatory framework is suitably adapted to capture the unique features of SBBSs. Importantly, enabling SBBSs does not involve changing the regulatory treatment of sovereign exposures. As set out in the May 2017 Reflection Paper on
4 See volumes I ("main findings) and II ("technical analysis") of the ESRB task force report "Sovereign
bond-backed securities: feasibility study", available at:
the deepening of the Economic and Monetary Union, the latter would have profound implications, including in terms of financial stability and level-playing field for EU banks.
• Consistency with existing policy provisions in the policy area
As SBBSs represent a novel concept and do not yet exist in practice, no appropriate regulation for this kind of instrument has yet been created that would take into account their unique properties.
Under the current legal framework, as indicated above, SBBSs would be defined as securitisation products. Thus, as a result of the regulatory framework for securitisations – which is, as such, appropriate for existing securitisations – investing in SBBSs would be associated with higher regulatory charges than investing directly in euro area sovereign bonds, which constitute SBBSs' underlying portfolio. For example, when it comes to capital requirements for banks, euro area sovereign bonds are zero-risk weighted (that is, banks need not hold any capital against their investment in these bonds), but investments in securitisation tranches are associated with positive and—depending on the seniority—often quite high capital requirements.
The justification for these higher charges for securitisation products in general (the so-called “non-neutrality” of the securitisation framework) lies in securitisation-specific risks, primarily due to asymmetric information between the originator of the securitisation products and the investors. This is typically compounded by the opaque nature of the securitised assets and the complexity of the structure, which entail agency risks and legal risks. In typical securitisations, agency risks stem from the fact that originators of such products know substantially more than investors about the assets composing the securitisation pool. This is obviously the case where, for instance, a bank issues mortgages and then securitises them. An investor does not have access to the same information on the mortgage borrowers as does the bank. Thus they may also assume that the bank may 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 some exposure to the underlying assets.
However, SBBSs are a specific financial product with two key characteristics. First, many of the asymmetries of information and complexities of a typical securitisation structure are not present because SBBSs' underlying pool is composed of euro-area central government bonds. These assets are well known and understood by market participants. Moreover, the structure of the underlying asset pool for SBBSs is pre-determined (e.g., the weights of the individual Member States' central government bonds would be in line with their contribution to capital of the European Central Bank, with little deviation). Second, euro area sovereign bonds are regularly traded in the markets. This means that anyone can acquire a financial exposure to them without resorting to securitisation.
Hence, securitisation-specific regulatory charges are not justified for SBBSs as defined in this regulatory proposal.
This proposal addresses a similar problem as has been addressed with the recent Simple, Transparent and Standardised (STS) Securitisation Regulation. Specifically, the rationale for the recent STS Regulation (Regulation (EU) 2017/2402) is that, in the presence of securitisations which are structured in a simple, transparent and standardised way and according to EU standards, failing to recognise such properties with a specific (and, in practice, more favourable) regulatory treatment would have unduly hindered their development.
Given the special nature of SBBSs' underlying assets, namely euro area central government bonds, the wedge between the regulatory treatment of (traditional) securitisations and the actual risk/uncertainty of the instrument is even more pronounced for SBBSs than was the case for STS securitisations. This is for two reasons: (1) the underlying assets (i.e. namely, euro area sovereign bonds) are even more simple, transparent and standardised; and (2) euro area sovereign bonds themselves 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 because of the volumes involved, the strong competition, and the high market liquidity. Relevant costs, from the viewpoint of a financial institution intending to invest in such assets, include the cost of capital associated with their purchase. Therefore, failure to address this regulatory barrier is likely to have a correspondingly greater impeding effect on the developments of the market for SBBSs than would have been, for example, the case for STS securitisations.
• Consistency with other Union policies
Reducing risks to financial stability by facilitating the diversification of banks' sovereign portfolios and further weakening the bank-sovereign nexus is of high importance for the completion of the Banking Union.
This legislative proposal is part of the Commission's efforts to enhance Banking Union and Capital Markets Union. It aims to enable the emergence of an efficient market for SBBSs over time. In turn, SBBSs could support further portfolio diversification in the financial sector, while creating a new source of high-quality collateral particularly suited for use in crossborder financial transactions. Also, it could render sovereign bonds issued in otherwise small and less liquid markets more attractive for international investors. This would foster private-sector risk sharing and risk reduction and promote a more efficient allocation of risks among investors. Furthermore, enabling SBBSs would increase the range of available instruments on financial markets, which feeds into the Commission's efforts to deepen and integrate further Europe's capital markets in the context of Capital Markets Union. By thereby helping to complete Banking Union and advance Capital Market Union, SBBSs would effectively contribute to the advancement of the Financial Union and the deepening of Economic and Monetary Union.
As mentioned, SBBSs will be a market-based instrument which is likely to develop gradually over time, as an alternative and complementary investment opportunity, next to sovereign bonds. SBBSs are not expected to have any material negative impact on existing national bond markets and are not expected to replace them.
SBBSs are conceptually distinct and different from the European safe asset as discussed in the May 2017 Reflection Paper on the deepening of the Economic and Monetary Union. The European safe asset – differently from SBBSs – would be a new financial instrument for the common issuance of debt. Developing such European safe asset raises a number of complex legal, political and institutional questions that need to be explored in great detail. It would have to be designed in line with the limitations in the Treaty in terms of public sector risk sharing and in particular the 'no bail-out clause' (Art. 125 TFEU). In the Roadmap as presented in the above-referenced Reflection Paper, the issuance of such a European safe asset is envisaged as a possible further step during the years until 2025. It is, therefore, an innovation for the medium term.
2. LEGALBASIS, SUBSIDIARITYAND PROPORTIONALITY
• Legal basis
SBBSs are a tool to enhance financial stability and risk sharing across the euro area. They can thereby further deepen the internal market. This proposal thus has as legal basis Article 114 TFUE, which confers to the European institutions the competences to lay down appropriate provisions that have as their objective the establishment and functioning of the internal market.
• Subsidiarity (for non-exclusive competence)
The identified regulatory impediments to the development of SBBSs markets are laid down in several pieces of Union legislation5. As a consequence, 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.
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 opaque and would segment market demand in various different instruments. This would make it difficult or even impossible for any one of them to acquire the requisite liquidity. Furthermore, even if they all targeted the same instrument, national legislators could end up engaging in a race to offer to such instrument a regulatory treatment that is as favourable as possible. In both cases, i.e. addressing differently defined products or giving different regulatory treatment, national-level action would create obstacles to the single market. 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. For all these reasons, action at the EU level is necessary and appropriate.
• Proportionality
The proposed regulation aims at enabling the new instrument by removing regulatory barriers to the gradual emergence of an SBBSs market. This intervention is proportionate by levelling the playing field between the new instrument and its underlying assets. The proposal is not expected to have any material impact on existing national sovereign bond markets.
• Choice of the instrument
This proposal aims at enabling a demand-led market development of SBBSs. To this end, the proposal provides for the criteria to be met by the instrument to be labelled as SBBSs and provides the necessary supervisory framework.
In order to achieve the targeted benefits, it is necessary that a standardised product is enabled. This standardisation should be uniform across the EU, thus a fully harmonised definition and regulatory treatment of SBBSs at EU level is required. Article 114(1) TFEU provides the legal basis for a Regulation creating uniform provisions aimed at improving the functioning of
Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (CRR) (OJ L 176, 27.6.2013, p.
1); Commission Delegated Regulation (EU) 2015/35 of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) (OJ L 12, 17.1.2015, p.
1); Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective
5
the internal market. A Directive would not lead to the same results, as implementation of a Directive, due to the discretion exercised when transposing it, might lead to differences, which, in the case of the SBBSs market, could lead to distortion of competition and regulatory arbitrage.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER
Contents
- CONSULTATIONS
- Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a
- Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European
- Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on
- This
- Commission Delegated Regulation (EU) 2015/61 of 10 October 2014 to supplement Regulation (EU)
- Commission Delegated Regulation (EU) 2015/35 of 10 October 2014 supplementing Directive
- 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the
- Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the
ANDIMPACTASSESSMENTS
Stakeholder
consultations
As part of its SBBSs feasibility assessment, the ESRB task force conducted a public consultation in late 2016 and obtained input and feedback from the industry, i.e. various financial institutions, and from public debt management officers (DMOs), through a range of bilateral meetings as well as two dedicated workshops in 2016 and 2017. The Commission did not launch an open public consultation of its own to avoid duplication. It should be noted that the proposed initiative is not directed towards consumers or retail investors.
The above-mentioned consultation among industry representatives sought feedback on several key issues regarding the possible implementation of SBBSs, in particular regarding the regulatory treatment and the economic aspects of SBBSs. The feedback, in particular, showed strong consensus on the increasing scarcity of 'safe' (low-risk) assets in the market. The majority of respondents were of the view that at least senior SBBSs should receive the same regulatory treatment as their underlying sovereign bonds.
While market participants overall agreed that deeper financial integration and a diversification of banks' sovereign portfolio would be necessary in Europe, views were mixed as to the viability of SBBSs. In particular, the marketability of the junior tranche of the product was questioned. Participants broadly agreed that for an SBBSs market to emerge, the following would be required: (1) coordination of issuances by Debt Management Officers (DMOs);
a regulatory framework that levels the playing field between sovereign bonds and SBBSs;
simple and standardised SBBSs characteristics, including a fixed portfolio weights on the asset side and a maximum of three tranches on the liability side; i sufficient liquidity in the SBBSs market; and (5) clarity on the procedure in the event of a (selective) sovereign default. A detailed breakdown of answers on key questions and general conclusions drawn from the survey are presented in Volume II of the above-referenced ESRB task force report.
In a dedicated workshop, DMOs raised concerns regarding the design and implementation of SBBSs and took the view that SBBSs would neither to break the bank-sovereign nexus nor create a euro area low-risk asset. More specifically, DMOs' concerns related to the impact of SBBSs on national sovereign bond markets (in particular on their liquidity), the implications of primary and/or secondary market sovereign bond purchases by SBBSs issuers, and the possible regulatory treatment of SBBSs. They also voiced concerns about the technical feasibility and economic viability of the new instrument.
Besides the above mentioned stakeholder consultations as part of the ESRB feasibility assessment, the Commission reached out to Member States and organised a meeting of the Commission's Expert Group on banking, payments and insurance (EGBPI) on 11 April 2018 in order to receive technical feedback on specific questions. Participants pointed to the need to first discuss the necessity of SBBSs before providing technical advice, as in their view the need for SBBSs was not obvious. They provided useful views on select technical issues, in particular calling for greater flexibility to market participants when it comes to determining
the fundamental characteristics of SBBSs (i.e. with respect to the weights of different Member States' sovereign bonds in the underlying portfolio or the tranching levels).
Collection
and use of expertise
The Commission actively contributed to the work of the above-mentioned ESRB task force. This regulatory proposal builds to a large extent on the work of the task force. Further, the Commission has met with public authorities and private sector representatives to seek their expertise and corroborate the findings of the task force.
Impact
assessment
For the preparation of this proposal, an Impact Assessment was prepared and discussed with an Inter-service Steering Group on several occasions. The Impact Assessment considered the following policy choices: (i) the scope of applicability of the proposed framework (i.e., to any securitisation of euro area sovereign bonds, or only to those complying with certain standardisation requirements); (ii) whether to restore 'regulatory neutrality', i.e., grant the same treatment as that of the underlying sovereign bonds only to the senior tranche of SBBSs issue or to all tranches of SBBSs issue; and (iii) how to monitor and ensure compliance with the proposed framework (i.e., whether through a self-attestation approach or via ex-ante certification).
The Impact Assessment highlighted several important trade-offs. For example, removing regulatory impediments for all and any securitisations would allow maximum flexibility to market participants to design the new instrument to maximize returns while minimizing risks. On the other hand, a certain degree of prescribed standardisation might better ensure that the liquidity of the new instrument is not dissipated across many different variants. Similarly, whereas granting the same treatment of sovereign bonds only to the senior tranche may give greater incentives for banks to focus on senior tranches, such an approach would be inconsistent with the current regulatory treatment of sovereign exposures (and would be less 'enabling' of SBBSs in general, since it would have reduced the potential investor base).
The Impact Assessment assessed the effects of the various options on the extent to which the identified regulatory hindrances would be removed, the extent to which the new instruments would help with risk-reduction in banks' balance sheets and with expanding the supply of euro-denominated low-risk assets, and the benefits of the various compliance and supervision approaches in terms of instilled market confidence vis-à-vis the associated costs (both public and private).
Because the proposed framework only enables the private-sector led development of an SBBSs market, but does not guarantee it, the Impact Assessment considered two distinct scenarios to evaluate impacts, one in which SBBSs reach only a limited volume (EUR 100 billion) and a steady-state one in which they reach EUR 1,5 trillion—a macro-economically relevant volume (albeit still contained relative to the overall euro area sovereign debt market, which amounted to EUR 9 trillion as of the second quarter of 2017).
A quantitative indication of the significance of the obstacles that would be removed with this proposal can be obtained by comparing, e.g., the capital requirements banks would incur if they bought SBBSs today versus those they would incur for the same purchases under the proposed bespoke regulatory framework. Of course, such (virtual) savings would depend on the assumptions made (including on the risk weights warranted by the sub-senior tranches). In the limited-volume scenario assuming banks purchase all tranches, and that banks using the
standardised approach account for a share of such purchase equal to their current share of government bond purchases, aggregate risk-weighted assets would increase by some EUR 87 billion. For the steady state scenario the equivalent calculation yields an increase in aggregate risk-weighted assets to the tune of EUR 1.3 trillion.
When it comes to the impact on the volume of euro-denominated AAA-rated assets, the calculation is based on Eurostat data on euro area central government debt as of December 2016,6 as well as Standard & Poor's ratings of euro area sovereign governments on the same date.7 This calculation shows that AAA-rated assets would increase by 2% (respectively, 30%) in the limited-volume (respectively, steady state) scenario.
Finally, as regards the impact of SBBSs on the diversification of banks' sovereign portfolios, the analysis in the Impact Assessment 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 transparency exercise conducted by the European Banking Authority would be reduced by 42%.
The Impact Assessment report was submitted to the Regulatory Scrutiny Board on 19 January 2018. The board meeting took place on 14 February 2018. The Board gave a positive opinion and called for changes and additional input in the following areas: (1) to clarify whether this initiative aims at providing an enabling framework and market test or an incentive structure for SBBSs; (2) to develop further the initiative's potential net public benefit, as well as risks or unintended consequences; and (3) to better present the trade-offs between alternative policy proposals. These issues have been addressed and incorporated in the final version which accompanies this proposal.
Regulatory
fitness and simplification
initiative does not aim at simplification or reduction of administrative burden resulting
from existing legislation, but instead provides for new rules to enable the development of SBBSs instruments in the market.
The regulatory proposal is not expected to directly affect retail investors, households, SMEs or micro-enterprises, because it is unlikely that they would be active in SBBSs markets. At the same time, these sectors would benefit indirectly from this regulatory proposal as a result of enhanced resilience of the financial sector – to the extent that the expected macroeconomic and financial-stability benefits materialise.
• Fundamental rights
This proposal complies with the fundamental rights and observes the principles recognised in particular by the Charter of Fundamental Rights of the European Union, notably the rights to property and the freedom to conduct a business, and has to be applied in accordance with those rights and principles. In particular, this Regulation ensures the protection of SBBSs investors' rights by ensuring the integrity of the issuance of SBBSs and of the underlying portfolio of sovereign debt.
6 Downloaded from Eurostat website on 21 December 2017 at 10:42.
7
4. BUDGETARYIMPLICATIONS
This regulatory proposal will have limited novel financial implications for public budgets, since the compliance mechanism would be based on self-attestation by SBBSs issuers and supervisors would check compliance ex-post in the course of their routine supervisory activities. In view of the envisaged new tasks, and taking account of possible synergies with its existing functions, some additional resources are necessary for ESMA (see legislative financial statement). Issuers of SBBSs would incur the self-attestation costs, which should however be quite small given the simplicity of the financial product (the extent to which these are translated to investors would depend on the competitiveness of the market).
5. OTHERELEMENTS
• Implementation plans and monitoring, evaluation and reporting arrangements
The specific objectives of this initiative—i.e., to eliminate regulatory hindrances and to contribute to the liquidity of the new SBBS products, including by granting them 'benchmark' regulatory treatment—would indeed be achieved once the proposed legislation enters into force. This is the case because only a standardised product would then be eligible for the envisaged specific regulatory treatment and the regulatory treatment of SBBSs would be equated to that of the underlying sovereign bonds.8
In terms of the general objective to enable markets for SBBSs, the impact of the legislation will be assessed by monitoring the extent to which these new products will actually be assembled and traded and the extent to which the emergence of SBBSs contributes to expansion in the amount of low risk assets and reducing banks' 'home bias'. The impact of SBBSs on the liquidity of national sovereign bond markets will also be assessed.
When interpreting the results of these analyses, it needs to be kept in mind that the development of SBBSs markets and the evolution 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 from these other factors. In particular, the supply of new products is also likely to depend on the legal costs of setting up the issuing vehicle, the ease of procuring bonds of sufficiently uniform terms, the costs of servicing the structure, etc. Similarly, their demand will depend on the overall interest rate environment, risk appetite, and the demand from various investor types for the different tranches. Market developments may well be non-linear, as the envisaged product will benefit from returns to scale from size and network externalities. Thus, for example, if the product appears to attract sufficient investor interest, debt managers may decide to organise dedicated auctions for the production of SBBSs, with standardised bonds of varying maturities. This would in turn reduce production costs and could accelerate the growth of the market.
• Detailed explanation of the specific provisions of the proposal
This proposal contains four parts. The first part provides a set of rules that define the constitutive elements of SBBSs. These rules are necessary to ensure that as standardised a product as possible is produced by the markets. This in turn favours its liquidity and appeal to investors. The second part provides rules that define notification and transparency
Some specific hindrances, e.g. differential eligibility for liquidity coverage requirements between SBBS and euro area sovereign bonds, would be addressed in separate pieces of legislation, as they stem from
8
requirements for the issuing entity to ensure that self-attestation is performed in a harmonised and credible way. The third part contains rules regarding the supervision of SBBSs and possible sanctions in case of non-compliance and/or fraudulent behaviour of the issuing entity. The fourth part contains a set of amendments to the existing legal framework required to grant SBBSs a regulatory treatment in line with their unique design and properties.
Introductory provisions (Articles 1 to 3)
The provisions explain the subject matter, scope and the definitions used for the purposes of providing a general framework for standardised SBBSs and entities involved in the issuance and the holding of such instruments. The definitions used are consistent with those used in other pieces of Union law.
Eligibility and composition of the underlying portfolio and tranching of SBBSs issues (Articles 4 to 6)
The underlying portfolio of SBBSs should be composed of sovereign bonds of all EU Member States whose currency is the euro. This restriction is to ensure that none of the bonds in the underlying portfolio of SBBSs is affected by currency risk. The relative weight of the sovereign bonds of each Member State should be very close to the relative weight of the respective Member State' participation to the ECB capital key. The ECB capital key is a proxy of each Member State's economic size and its stake in the stability of the European financial system. Other keys have been considered but have been found to be inferior. For example, a key based on each Member State's outstanding sovereign debt could give rise to moral hazard, whereby a Member State may benefit more from the product if it increases its overall outstanding debt.
Maturities of underlying sovereign bonds should be closely aligned to the maturity of the SBBSs issue.
An SBBSs issue should be composed of a senior tranche, corresponding to 70 percent of the nominal value of SBBSs issue, and one or more subordinated tranches.9 The purpose of the subordinated tranches is to provide protection to the senior tranche, which therefore is a low-risk instrument. The precise split of the subordinated portion of the SBBSs issue construction in the various tranches is left at the discretion of the issuer, who will maximize the total price including by catering to the specific risk/return demand of various investor types. The senior tranche is set at 70 percent of the overall structure to ensure standardisation of this tranche across different issues. To limit the risk of the junior tranche (the tranche bearing losses before any other tranche), the nominal value of the junior tranche should be at least 2 percent of the outstanding nominal value of the entire SBBS issue. The ESRB task force has shown by way of a comprehensive analysis that a 30-percent thick subordinated tranche is sufficient to ensure low risk of default for the corresponding (that is, 70 percent thick) senior tranche including in scenarios of market stress.
Articles 4 and 6 foresee specific circumstances in which the structure of the SBBSs issue (composition of underlying portfolio and size of senior tranche) can be changed for future issuances and describe the relevant procedures. Sovereign bonds of a particular Member State may be excluded from the underlying portfolio when and until the issuance of sovereign bonds by a Member State is significantly limited due to a reduced need for public debt or
In the version analysed by the ESRB task force there were two subordinated tranches, a mezzanine and
9
impaired market access. Also, the tranching structure may be changed in exceptional cases where adverse market developments that severely disrupt the functioning of sovereign debt markets in a Member State or in the Union require a smaller senior tranche to ensure its continued high quality/low risk. ESMA is tasked to monitor whether the conditions for a change in the composition of the underlying portfolio or in the size of senior tranche exist and to inform the Commission accordingly. The Commission may decide that such conditions exist or have ceased to exist by adopting an implementing act. Such an implementing act could only enter into force following a vote by Member States representatives in the European Securities Committee, in accordance with the examination procedure. SBBSs issued after the adoption of such an implementing act shall reflect the changes in the composition of underlying portfolio or the size of senior tranche for which the implementing act was issued.
Issuance and management of SBBSs (Articles 7 and 8)
To ensure that investors are protected from the risk of insolvency of the institution that acquires the sovereign bonds (original purchaser, typically a bank), the issuance of SBBSs should be undertaken by a Special Purpose Entity (SPE) that is exclusively devoted to the issuance and management of SBBSs and that does not undertake any other risky activities, such as provision of credit.
The SPE should be subject to strict asset segregation requirements to ensure the integrity of the SBBSs issue and of the positions held by SBBSs investors. SPEs should ensure that the composition of the underlying pool of sovereign bonds is fixed throughout the lifecycle of an SBBSs. To manage limited maturity mismatches, SPEs should be allowed to invest the proceeds from the underlying portfolio only in cash or in highly liquid financial instruments with low market and credit risk.
Since investors in SBBSs issues’ tranches would have claims only on the underlying portfolio of sovereign bonds, but not on the issuer's or original purchaser's balance sheet, the SPE and its underlying portfolio should not need to be consolidated in the portfolio of the original purchaser.
Use of the designation Sovereign Bond-Backed Securities (Article 9)
To ensure the standardisation of SBBSs, only those products that fulfil the requirements regarding the composition and maturity of the underlying sovereign bonds and the tranching should enjoy the same regulatory treatment as that of the underlying sovereign bonds. A system of notification to ESMA is set out to ensure that no abuses are committed. A product can thus be qualified as SBBS only if both the substantive and notification requirements have been fulfilled.
SBBSs notification and transparency requirements (Articles 10 to 12)
The SPEs are responsible for compliance with the product and notification requirements. ESMA is entrusted with the publication of notifications on its website. This will ensure that the SPEs take responsibility for claiming that a product qualifies as an SBBS and that there is transparency in the market. SPEs shall be liable for any loss or damage resulting from incorrect or misleading notifications under the conditions stipulated by national law. Investors will have to perform the due diligence required for any investment in financial products but may place appropriate reliance on the SBBSs notification and the information disclosed by SPEs concerning compliance with specific SBBSs product requirements. Transparency requirements imposed on SBBSs and underlying sovereign bonds should allow investors to
understand, assess and compare transactions in SBBSs and not to rely solely on third parties, such as credit rating agencies. They should allow investors to act as prudent investors and do their due diligence. This proposal ensures that investors will have all the relevant information on SBBSs at their disposal. To facilitate the process for investors and SPEs, the information to be provided to ESMA will be harmonised and a template will be developed by ESMA for the assessment of SBBSs. SPEs should make the information freely available to investors, via standardised templates, on a website that meets certain criteria such as control of data quality and business continuity. Moreover, before the transferring of SBBSs investors should receive information regarding the allocation of proceeds and the procedure to be followed in anticipation or following a non-payment of an underlying asset. To allow supervisory authorities to be informed and perform their tasks related to the issuance of an SBBSs issue, ESMA should inform the relevant competent authorities of each notification of SBBSs received.
Supervision and cooperation among authorities (Articles 13 and 14)
To safeguard financial stability, ensure investors' confidence and promote liquidity, a proper and effective supervision of the SBBSs markets is important. To this end, the proposal requires Member States to designate competent authorities in accordance with existing EU legal acts in the area of financial services. Compliance with the requirements set out in the Regulation should be primarily performed to ensure investors’ protection and, where applicable, on prudential aspects that may be linked to the issuance or holding of SBBSs by regulated entities. The designated supervisors should have the powers that are granted to it under the relevant financial services legislation.
In view of the cross-border nature of the SBBSs market, cooperation between competent authorities and the ESMA should be ensured through information exchange, cooperation in supervisory activities and investigations and coordination of decision-taking.
To ensure a consistent interpretation and common understanding of the SBBSs requirements by competent authorities, ESMA should facilitate the coordination of the work of competent authorities and assess practical issues which may arise with regards to SBBSs.
Sanctions and remedial measures (Article 15 to 18)
As a deterrent to prevent abusive behaviour and keep trust in the product, appropriate administrative sanctions and remedial measures should be provided for situations where a product that is declared by an SPE to be an SBBS does not fulfil the requirements for that product to be considered an SBBS or other notification or transparency requirements. The fact that a product which is declared to be an SBBS is effectively that is of particular importance to ensure investors’ protection. For this reason, Article 15 provides for a specific procedure according to which a competent authority has to decide whether a product which is suspected not to comply with the requirements set out in the Regulation is an SBBS or not. Where criminal sanctions for certain infringements are provided for under national law, competent authorities should have the powers to transmit to ESMA and other competent authorities relevant information regarding criminal investigations and proceedings related to the infringement. Sanctions inflicted to an SPE should be published. Moreover, an SBBS that is found not fulfilling the requirements laid down in the proposed Regulation should be removed without undue delay from the list of SBBSs compiled by ESMA.
Macroprudential monitoring (Article 19)
According to the analysis performed ahead of the issuance of this proposal it appears that SBBSs will not have impact on the liquidity of other financial products on the market or have an impact on financial stability. However, since SBBSs are a new product it is appropriate that the ESRB, within its mandate, monitor the development of the market.
Notifications (Article 20)
Member States shall notify the Commission and ESMA about the laws, regulations and administrative provisions related to the implementation of supervisory and sanctioning obligations provided for in the Regulation.
Amendments to other legal acts (Articles 21 to 24)
Articles 21 to 24 amend some articles of other legal acts, in particular the undertakings for collective investment in transferable securities (UCITS) Directive, the Capital Requirement Regulation (CRR), the institutions for occupational retirement provision (IORP II) Directive and the Insurance (Solvency II) Directive. These modifications are needed to ensure that investments in SBBSs receive in all financial sectors regulated at European level a regulatory treatment equivalent to the one given to their underlying assets, i.e. euro area sovereign bonds.
In particular, UCITS need to respect diversification rules, which may prevent them from holding certain volumes of SBBSs. The aim of amending the UCITS Directive is to ensure that when Member States authorise UCITS to invest up to 100% in transferrable securities issued or guaranteed by a public body, this exception is also granted to SBBSs. To this end a new Article 54a is inserted in the Directive.
For insurance companies, SBBSs would be treated as securitisation. Under the Solvency II standard formula, any securitisation is subject to capital requirements related to spread risk in the calculation of the basic solvency capital requirement. SBBSs would therefore be subject to capital requirements for spread risk, putting them at a disadvantage relative to direct holdings of Member States' central government bonds denominated and funded in domestic currency. Article 104 of the Solvency II Directive is thus amended by adding a new paragraph, to ensure that for the purposes of the calculation of capital requirements, SBBSs are treated as Member States' central government and central banks denominated and funded in their domestic currency.
Similarly, the Capital Requirement Regulation is amended to ensure that capital requirements and exposure limits for institutions holding SBBSs are the same as holding Member States' sovereign bonds directly. This goal is achieved, through the addition of a paragraph to Article 268 (as modified by Regulation (EU) 2017/2401), by extending to all tranches of SBBSs issues the look-through approach granted to the exposure to securitisation positions in the calculation of capital requirements. This ensures that exposures to all tranches of SBBSs issues get the same prudential treatment as the underlying assets. In addition, by amending Article 304, the same treatment as granted to sovereign bonds in market risk capital requirements is granted to SBBSs. Finally, Article 390 is also amended to ensure that for exposure limits the look though approach used for securitisation is applied also to exposures to SBBSs.
For occupational pension funds, the IORP II Directive sets out spread risk limits that Member States may choose not to apply to investments in government bonds. Moreover, Member States may impose quantitative restrictions for securitisations. To ensure the same treatment for SBBSs, a new Article 18a is added in IORP II Directive.
The Commission will adopt the necessary changes to the delegated acts linked to the above mentioned pieces of legislation where necessary.
This is in particular the case for the Liquidity Coverage Ratio Regulation (Commission Delegated Regulation (EU) No 2015/6110), for which the change should ensure that SBBSs are qualified as Level 1 assets that represent claims on the central government of a Member State or that are guaranteed by a central government of a Member State, and insurance prudential requirements (Commission Delegated Regulation (EU) 2015/3511) to ensure that rules applicable to exposures of insurance companies to euro area sovereign bonds are also applicable to exposures to SBBSs.
Until the (relevant provisions in the) delegated acts based on these Directives and Regulations are amended, they will remain applicable as such.
The Commission will also adopt the necessary changes to the prospectus schedules and building blocks (Commission Delegated Regulation (EU) 2017/112912) to ensure that appropriate disclosure for this new type of financial instrument, tailored to the characteristics of the product, are set out. This should be done in a proportionate manner, taking into account the comparably simple nature of the product and with the aim of avoiding unnecessary administrative burden.
10
No 575/2013 of the European Parliament and the Council with regard to liquidity coverage requirement
for credit institutions (OJ L 11 17.1.2015, p.1).
business of Insurance and Reinsurance (Solvency II) (OJ L 12, 17.1.2015, p.
1).
prospectus to be published when securities are offered to the public or admitted to trading on a
11
12