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In a move the European Commission (EC) believes will lead to a stronger and more resilient economic and monetary union, the EC is removing what it sees as unwarranted regulatory obstacles to the market-led development of sovereign bond-backed securities (SBBS). The proposal would grant SBBS the same regulatory treatment as national euro-area sovereign bonds denominated in euro.
Risk reduction
The EC states that under the new rules, these securities would be issued by private institutions as claims on a portfolio of euro-area government bonds. SBBS would, by design, not involve mutualisation of risks and losses among euro area Member States. Only private investors would share risk and possible losses. Investing in such new instruments would help investors such as investment funds, insurance companies, or banks to diversify their sovereign portfolios, leading to more integrated and stable financial markets. It would also contribute to weakening the link between banks and their home countries, which despite recent progress remains strong in some cases. SBBS would not negatively affect existing national bond markets.
The ‘doom loop’
In an opinion piece entitled ‘the doom loop,’ on his Geopolitical Intelligence Services blog, Prince Michael of Liechtenstein argues this could pose a threat to some large banks. He writes that Euro area member states would find themselves in the ironic situation of offering bailouts to credit institutions that made the mistake of trusting their own governments in devastating vicious circle or ‘doom loop.’ Prince Michael explained ‘There doesn’t seem to be much difference between the asset-backed securities responsible for the 2007-2008 financial crisis and the European Commission’s proposals. In the former case, banks wanted to get subprime mortgage securities off their books because they were not secure; SBBS simply apply the same logic to government bonds that have lost their quality.’
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