The European Union’s long-held desire to be officially seen as a sovereign issuer in the capital markets is now on hold. This comes as Intercontinental Exchange (ICE) followed MSCI in declining to add the EU to its government bond indices following a consultation which began in April 2024. Inclusion in sovereign indexes would widen the EU’s investor appeal, cut borrowing costs and boost the euro’s status as a liquid and safe asset. The new European Commission, which takes office in the autumn, should make the sovereign recognition question a prime strategic objective.
ICE’s decision – which followed a consultation that began in April 2024 – was widely expected following MSCI’s ruling in June, but flew under the radar with no official announcement, even by way of press release. Instead, it merely included the decision in a ‘rule announcement’ under the ‘publications’ section of its website on Friday 2 August. The ensuing chaos in global markets on the following Monday kept the EU decision inconspicuous.
The decision was a non-event in terms of the impact to the EU’s bonds, albeit with a marginal sell-off. Much of the impact had already occurred following MSCI’s decision in June.
‘There was a lot of volatility in the market for other reasons so that makes it more difficult to assess [the impact to the EU’s bonds],’ said Christoph Rieger, head of rates and credit research at Commerzbank. ‘Secondly, many investors are on holiday so there are not much meaningful flows and thirdly, communication was not very good in the sense that the results were published on the website without a press release. We happened to have seen it by coincidence.’
Both ICE and MSCI have been criticised for the lack of communication throughout their respective consultation periods. ‘The process has not been transparent, and this is something we have complained about, especially with MSCI, where no one really knew who was involved and what the survey was about,’ said Rieger.
In a statement sent to OMFIF, MSCI said it ‘published the proposal on our website in May 2024 and communicated directly with clients’. ICE did not reply to a request for comment.
Lack of consensus
ICE did not give much detail as to why it rejected the proposal to include the EU in its government bond indices other than saying, ‘there were many views for and against this proposal, but nothing close to a consensus’. It added that those in favour of classifying the EU as a sovereign argued that the EU issues debt on behalf of euro area member states. But those against this argued that other supranational and agency issuers also issue debt on behalf of sovereigns while not being classified as sovereigns themselves. It went on to list the likes of the Council of Europe Development Bank, the European Stability Mechanism and the European Financial Stability Facility as examples of this.
This is valid in that these issuers do issue debt on behalf of European sovereigns while not being seen as sovereigns. But they are completely different types of issuers compared to the EU and do not issue anywhere near the amount nor the frequency that the EU does. The EU behaves like a sovereign in this sense with auctions, as well as syndications and a volume of supply that is on par with other European sovereigns.
Many investors already view and trade the EU as a sovereign, including central banks and official institutions who have migrated the EU from supranational to sovereign portfolios. The EU’s bonds have also been performing extremely well, demonstrating its increased demand and liquidity as a safe asset.
The 10-year segment in particular has been strong for the EU, with the issuer’s bonds trading through France since March 2024 and was quoted at 16 basis points through OATs on 7 August. With the EU trading through OATs, more investors are using the likes of Austria or the Netherlands as a hedge versus the EU rather than France.
However, the strong performance of the EU over France does require context. ‘The reason why the EU has managed to hold up well over OATs is because OATs have been at risk due to the French elections, budget and the pressure on their credit ratings,’ said Pooja Kumra, senior European and UK rates strategist at TD Securities.
Temporary setback
While it is a blow that both ICE and MSCI have declined to include the EU in its government bond indices, it is only a temporary setback.
ICE said that it ‘will continue to monitor investor views on this topic and would consider future consultations if consensus builds in support of a change’. Additionally, as a small consolation, ICE has created new indices for market participants to include EU debt.
Meanwhile, MSCI said it ‘intends to re-evaluate the eligibility criteria in the second quarter of 2025’ for the inclusion of EU bonds to its government bond indices.
‘What the EU is lacking versus other EGBs [European government bonds] is that fact they don’t have a futures and liquid repo market,’ said Kumra. ‘Both are crucial to achieving sovereign status, especially a futures markets, which helps to hedge risk. The EU has been working on building both these tools. Thus, we would be keen to see how indices like MSCI and ICE respond to this in their next review to consider the issuer in the sovereign index.’
The EU’s repo facility is expected to go live in the autumn. This will allow the EU to serve as a backstop for its primary dealers to cover potential short positions, which will contribute to increased liquidity. Meanwhile, a futures market for EU bonds is also moving closer to reality, although this will ultimately be launched by a derivatives exchange and market participants rather than the EU itself.
Burhan Khadbai is Head of Content, Sovereign Debt Institute at OMFIF.
OMFIF, in partnership with the European Commission, is hosting a special event in Singapore on 10 September for investors to better understand how EU bonds are developing into a global benchmark and safe asset in capital markets. For more details and to book your place, click here.
