The workshop gathered 109 participants from Europe’s central banks, financial ministries, market participant and financial market experts. Nordic representation was made up by Nordea’s Chief Economist, Helge J. Pedersen, Christian Lage, Group Chief Officer at PFA Asset Management and Per Callesen, Governor from Danmarks Nationalbank. We took the opportunity to learn more on where Europe is heading in its ambition to create a European Safe Asset.
Why is there a need for a euro Safe Asset?
The sovereign bond markets in Europe set the financial conditions for businesses and households across the euro area. Could the introduction of a common safe asset help address sovereign exposures and overcome the limitations in the current set-up in the euro area?
It is commonly known that, crises in the euro area would be less severe if banks instead held liquid euro-denominated assets not sensitive to sovereign risk. To address these problems, some authors have proposed the creation of a common euro area low risk (“safe”) asset backed by full or partial guarantees by member states. (Policy brief from Peterson Institure for International Economcis: Read more here)
The so-called “safety trilemma”, authored by Ad Van Riet, 2017, suggest that a common safe asset (as a Euro Area Sovereign Government bond) would be able to capture flight-to-safety capital flows in events of a markets stress, external shocks etc. and instead of flowing from one country to another, capital would primarily flow into the common safe asset.
Whilst the euro currency is generally considered a safe-haven for storing wealth and credibility towards the European Central Bank (ECB) is high, the same cannot be said about the euro area sovereign bonds. Germany’s government bonds are considered a safe-haven and, since 2010, Germany has enjoyed several inflows that has reduced government borrowing costs. It is safe to say that the safe asset of Europe, is considered to be the German 10-year bond.
Risky assets do not cause crises. It is those perceived as being safe that do
- Richard Milne (2011)
The caveat is that Germany is only as robust as the euro area is as a region. Thus, it’s recognition as a safe asset might well be an illusion. The euro area will remain vulnerable to external shocks unless the European policymakers try harder to ensure their sovereign bonds get the true recognition as safe-haven assets.
With this mind, the European Commission gathered industry experts to discuss how a European Safe Asset can be introduced as a new financial instrument for the common issuance of debt. This work has been ongoing for some years and the details were first outlined in the EMU deepening Reflection Paper.
With this in mind, we sat down with our Group Chief economist, Helge J. Pedersen to learn more of the European Commission’s work and what impact a Safe Asset introduction would have for the Nordic financial markets.
Q&A on European Safe Assets
Question: Helge, what is your view on the possibility of introducing a new European Safe Asset instrument?
Helge J. Pedersen: I believe that the pooling and tranching of cross-border portfolios of national sovereign bonds represents an interesting and attractive approach to create a Safe Asset Instrument. It would serve as useful instrument comparable to US and Japanese bond instrument that enjoy the safe-haven status. As an economist I take an particular interest in the broader macroeconomic effects from a potential introduction of a euro safe asset and try to assess if this could be an opportunity for higher investments and economic growth.
Question: What are the risks & benefits with Safe Assets?
Helge J. Pedersen: Without safe government bonds, the obvious downside can be that sudden shifts in expectations can give rise to a vicious cycle of higher risk premiums, rising private lending costs, decreased productivity and capital flight. This capital flight can be contained with efficient European Safe Assets in place. The Safe Asset could provide increased financial stability and help to facilitate diversification and remove abundant risk of bank’s sovereign bond holdings. Particularly, domestic risk exposure would be limited as the safe asset would be constructed as an area-wide low-risk asset and could be used a store of value and pricing benchmark. A common euro Safe Asset would improve the reliance, and geographical diversifications of banks and likely create a more homogenous and stable financing cost for corporations as well as consumers domiciled in the euro area. However, a potential downside is that local government may have less incentive to run a responsible fiscal policy.
Question: What would a Safe Asset look like?
Helge J. Pedersen: That is a topic of much debate. Many voices argue that a euro common safe asset would need to have the highest credit quality and a triple-A rating would be a necessary to become the undisputed safe asset I the euro area. Another aspect that requires attention is that the introduction of a euro safe asset would reduce the market liquidity and increase the financing cost for national sovereign bonds.
Question: What would be the impact in the Nordics (good/bad) if euro safe assets would become a reality?
Helge J. Pedersen: It depends in part on the construction of the new safe asset. At the time spoken it is proposed to be one that will pool part of the existing mass of sovereign bonds which then will form the basis for the issuance of new bonds, which again will be parted in a senior and a junior tranche. Probably with the ESM as issuer. However, I have sincerely difficulties to see that the credit quality even on the senior tranche of the new bond can be greater than that currently applicable to Germany. All things being equal, this means that the Nordic countries’ government bonds will be more attractive to investors and thus will trade at lower spreads to the new benchmark than today. It could even lead to lower interest rates on Nordic government bonds. But now let us first see if there is a genuine political support for the project among all of the euro area countries. To me it seems quite doubtful that countries like Germany and the Netherlands should be willing to replace their own safe assets with a new and by nature more complex structured euro bond.
To follow the development and discussion on European Safe Asset, we recommend the following outlets:
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1. Reflection paper on the deepening of the economic and monetary union (May 2017)
2. Addressing the safety trilemma: a safe sovereign asset for the eurozone by Ad van Riet (2017)
3. Sovereign bond-backed securities: a feasibility study by ESBR (January 2018)
4. Bloomberg: ESRB Task Force Plan for Euro Safe Assets Is Said to Be Ready by Alessandro Speciale & Esteban Duarte
5. Europe's Search for a Safe Asset by Peterson Institute for International Economics (October 2018)