Sovereign bond-backed securities

Transcription

1 Sovereign bond-backed securities Sam Langfield Principal, European Systemic Risk Board Rome 4 July 217 My views; not necessarily ESRB s

2 Outline Euro safe asset Why we need it How to make it Implications for fixed income markets Investor base Liquidity 2

3 Fragile status quo Monetary union is half-built CMU, BU Unifying omission: no common safe asset (inter alia) the absence of a risk-less asset creates complications of a serious nature ECB President Mario Draghi, 21 June 216 3

4 Complications of a serious nature part 1 Capital markets fragmentation No risk-free discount curve or standard collateral Asymmetric flight-to-safety worsens shocks 4

5 Domestic government debt holdings as % of total Complications of a serious nature part 2 Banks home bias creates endogenous risk 1% 8% 6% 4% 2% % 5 Nationalist banks

6 Policy menu à la carte Joint issuance Eurobonds Partial guarantees Blue Bonds No guarantees SBBS Nationalism Status quo 6

7 Policy menu à la carte: choose one! Joint issuance Eurobonds Optimistic Partial guarantees Blue Bonds No guarantees SBBS Incremental progress Nationalism Status quo Pessimistic 7

8 Policy menu à la carte Joint issuance Eurobonds Partial guarantees Blue Bonds No guarantees SBBS Feasibility study by ESRB Nationalism Status quo 8

9 Pooling diversification Tranching seniority Sovereign bond-backed securities (SBBS) Make low-risk euro assets through: Embedded diversification Contractual subordination (no mutualisation) A L Portfolio of central government bonds (ECB capital key weights) Senior Bond (calibrated for low-risk) Mezzanine Junior Bond 9

10 Key features of SBBS design Each government issues its own bonds Some fraction is bought and held by the SBBS-issuing entity or entities Program size is a policy choice Large enough to be liquid and meet policy objectives Small enough not to disrupt national markets Indicative medium-term size: 1.5tn (necessary condition: SBBS regulatory change) 1

11 Implications for fixed income markets Investor base for SBBS tranches Liquidity of national government debt markets 11

12 Catering SBBS to investors: senior tranche Senior comparable to lowest-risk euro sovereigns (c.7% thickness) Existing investors: domestic banks, insurers, funds Additional investors outside of euro area Holdings of EA general government debt ( ) Holdings of EU supranational bonds ( ) 12

13 Catering SBBS to investors: mezz and junior Mezzanine to target investment grade (c.2% thickness) Higher-yielding but could be held by investors with mandate restrictions Junior to target yield-seeking investors Small thickness (1%) to target a smaller market niche for lower-rated securities 13

14 billion Issuance of high-yield Junior SBBS: 15bn bn (Junior SBBS: 1% of 1.5tn)

15 billion Net change in high-yield securities: 88bn bn (Junior SBBS: 1% of 1.5tn) bn (HY bonds in SBBS: PT, GR) -1 15

16 trillion Total euro high-yield securities tn Sovereign bonds:.2tn Securitizations:.3tn 3 2 Corporate bonds: 4tn 1 Pre-SBBS Post-SBBS 16

17 trillion Total euro high-yield securities with SBBS tn 4.6tn Pre-SBBS Post-SBBS 17

18 Recap: effect of SBBS on markets Banks can diversify and de-risk their portfolios with Senior SBBS All countries benefit from investment-enhancing effect of rest-of-world demand for Senior SBBS Junior SBBS add 88bn to the 4.5tn HY euro debt market SBBS replace some fraction of government bonds traded in open markets 18

19 Effect of SBBS on liquidity SBBS would reduce free float of government bonds by about 2% Natural experiment: Eurosystem PSPP has hoovered up a similar fraction Did PSPP damage liquidity? 19

20 Eurosystem PSPP and national bid-ask spreads AT BE DE ES FI FR IE IT NL PSPP holdings as a fraction of outstanding central government bonds 2

21 Conclusion SBBS as an incremental deepening of EMU Endogenous risk reduction without mutualisation Re-channel capital flows and de-risk portfolios Effect on investor base Senior SBBS to enhance rest-of-world demand Junior SBBS to add 88bn to 4.5tn HY market Effect on liquidity PSPP: no effect for purchases below c.2% of stock ESRB feasibility study ongoing 21