Eurozone’s safe assets

ESRB Task Force’s conclusion on sovereign bond-backed securities

…is that a gradual development of a demand-led market for SBBS might be feasible under certain conditions. One necessary condition is for an SBBS-specific enabling regulation to provide the conditions for a sufficiently large investor base, including both banks and non-banks. To enhance financial stability, this regulation would need to treat the different tranches of SBBS according to their unique design and risk properties. For banks, regulating senior SBBS no more severely than sovereign bonds could incentivise them to hold these low-risk securities. The regulatory treatment of mezzanine and junior SBBS should reflect their greater riskiness.

High-Level Task Force on Safe Assets
From: European System Risk Board

How safe are SBBS?

Cronin and Dunne VAR-based Diebold spillover index methodology to assess whether and how would the introduction of sovereign bond-backed securities (SBBS) senior bondholders from default -related losses. They conclude:

A lower spillover of shocks between SBBS securities compared to what arises between eleven member states’ bond markets is observed. Spillover values fall during the euro area sovereign bond crisis. Gross and net spillovers are lower for a 70-30 tranching than for a 70-20-10 case but in both cases the senior tranche becomes more insulated from shocks in the more junior tranches during periods of financial stress.

How effective are sovereign bond-backed securities as a spillover prevention device?
Authors: David Cronin, Peter G. Dunne
From: ESRB