06 December 2011

AFME's proposals for common eurozone sovereign issuance

This report from the Association for Financial Markets in Europe is intended to offer policymakers an insight into views of bond market participants on the practicalities of common eurozone sovereign issuance.

The report has benefited from the contributions of a dedicated group of experts from 22 of AFME’s sell-side member firms, along with specialists from eight member and non-member firms from the investor community.

In this report, AFME suggests a framework to determine the attributes essential for the success of a common eurozone sovereign bond – which we refer to as a eurobond ‐ and suggests three different structures that have a reasonable probability of success. AFME examines these structures from the perspective of the financial markets. Political and legal considerations, although impossible to exclude entirely, are not the prime focus of its analysis.

Any eurobond structure would demonstrate a combination of three primary attributes: type of issuing agent, liability structure, and number of tranches. The ‘number of tranches’ attribute is best explained using the example of blue and red bonds. The terms blue bond and red bond were introduced by the Bruegel institute in May 2010. Its proposal, which builds on earlier studies of AFME/Primary Dealers in 2008/2009, suggests that sovereign debt in euro area countries be split into two parts. The first part, the senior ‘Blue’ tranche of up to 60 per cent of a Member State’s GDP, would be pooled among participating countries and jointly and severally guaranteed. The second part, the junior ‘Red’ tranche, would retain debt in excess of 60 per cent of GDP as a purely national responsibility. Such an issuance structure would therefore have two tranches of blue and red bonds. The terminology blue and red bonds is used in two of the three structures presented in this paper. Note that sovereign debt in the eurozone is currently issued in a single tranche structure.

For the purpose of this report, a ‘perfect’ eurobond is defined as a structure that allows a large amount of funds to be raised in capital markets over an extended period of time. Such a eurobond would have the highest possibility of success. Given the constraints that we must realistically apply from a market perspective, the combination of primary attributes that would best deliver this aim is:

1. Issuing agent: Issued by a fiscal authority with the power to tax and spend;
2. Liability: Jointly and severally (J&S) guaranteed by all member states; and
3. Number of tranches: Having only one tranche on which every member state relies for issuance

At the other extreme, the least attractive structure would be:

1. Issuing agent: Issued by a Special Purpose Vehicle (SPV);
2. Liability: Severally guaranteed; and
3. Number of tranches: Issued in two or more tranches.

Between these two extremes are six other possible combinations of these attributes. AFME believes that a successful eurobond needs a minimum of one‐and a‐half primary attributes.

Full paper

© AFME