Should SSA and sovereign markets be grouped together?

Public sector bond market divided over how to boost liquidity in Europe

There is an argument that grouping all European sovereign, supranational and agency debt as one would boost the availability of liquid safe assets in the continent.

Boosting liquidity in the SSA bond market and the challenges facing issuers were discussed in detail at OMFIF’s Public sector debt summit. Around 20 global SSA borrowers, a similar number of investors as well as other key market participants explored important issues facing the public sector bond market.

‘We have to get rid of the split of SSA markets and sovereign markets, because this is all public debt,’ said a senior funding official at a European borrower. ‘I spoke recently to a hedge fund who said they can buy and take more positions in govvies [government bonds] because it’s a govvie and not an SSA. This doesn’t make sense if you compare smaller govvies with large SSAs.’ There are some SSA borrowers, including some German states, that have larger funding programmes than some sovereigns.

The funding official also argued that removing the split between SSAs and sovereigns would create a larger pool of liquid safe assets in Europe and strengthen the international role of the euro. He added the classification between SSAs and sovereigns should instead be based on liquidity and credit.

Who would be in charge of removing this classification between SSAs and sovereigns? ‘I don’t think this is a question for markets,’ said a sovereign debt portfolio manager. ‘It’s a question for the regulators.’ However, there is no legal definition of what a sovereign or an SSA is in the capital markets.

The EU as a sovereign issuer

Since reinventing itself as a super-sized borrower, the European Union has been working on being accepted universally as a sovereign rather than supranational issuer. However, the portfolio manager highlighted some concerns for the EU’s classification as a sovereign given its finite status as a large and sovereign-like borrower. ‘No one is sure whether the EU is going to be a permanent issuer and, because of that, if I’m buying those bonds, I’m not sure what the end game is.’

The lack of clarity on the EU’s status as a permanent large issuer in the capital markets is perhaps the biggest challenge it faces in being accepted as a sovereign borrower. But while net funding under its Next Generation EU programme ends in 2026, the EU will still roll over debt with funding needs of €40bn-€50bn in the 2030s, which is akin to a mid-sized sovereign borrower.

The EU will also have funding needs for its other programmes, such as its Macro-Financial Assistance programme, through which it has been disbursing loans to support Ukraine – positioning the EU as an important vehicle to support other crises in the future.

The EU is steadily progressing towards being accepted universally as a sovereign borrower. It has adopted a unified funding approach whereby all of the issuance under its various funding programmes is classified as ‘EU bonds’ to avoid fragmentation in its curve. The EU will introduce quoting commitments for its primary dealers from the second half of the year, which will boost secondary market liquidity.

Meanwhile, from 29 June, the EU’s bonds will be classified under haircut category I – the same as government bonds – making them more favourable for use in repurchase transactions with the European Central Bank. However, from a pricing perspective, the EU’s bonds are more similar to an SSA than a sovereign, which is a challenge the EU funding team faces.

Another senior funding official at a European borrower said some SSAs have made themselves distinct from sovereigns in the way they issue bonds by allocating primarily to real-money investors who buy and hold bonds, which leads to lower levels of secondary trading and liquidity. ‘Have the issuers themselves created a lack of liquidity in the market?’ he asked.

The need for more liquid safe assets in Europe was highlighted by other borrowers at the summit. ‘We strongly believe that we need more safe assets in the euro area – safe assets that can serve as a benchmark for pricing other securities or that can be used as a safe haven in case of market turbulences,’ said an official at a European SSA. ‘A large, safe asset base also contributes to good liquidity conditions. So, we really welcome the arrival of the EU because we think that there are not enough safe assets in the euro area.’

Whether the split between SSAs and sovereigns should be removed to boost the availability of euro liquid assets is something that market participants do not agree on. In a snap poll carried out by the OMFIF Sovereign Debt Institute’s LinkedIn page between 26-30 May, results were split 50-50, for and against.

Burhan Khadbai is Head of Content at the Sovereign Debt Institute at OMFIF.

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