Commissioner Hahn: EU bonds moving closer to sovereign status

Brussels: It is no secret that the European Union has held an ambition to be seen as a sovereign issuer since the start of its journey as a frequent and large borrower in the capital markets. This goal is now moving ever closer to reality as the stock of EU debt grows. More importantly, government bond index providers are looking to include EU bonds alongside benchmark European government bonds.

‘We are growing out of the sovereign, supranational and agency market into the market of sovereign bonds,’ said Johannes Hahn, European Commissioner for budget and administration at the OMFIF EU-Bonds summit in Dubai.

Hahn referenced the reclassification in 2023 of EU bonds under haircut category I, the same as government bonds, making them more favourable for use in repurchase transactions with the European Central Bank. The EU also introduced quoting commitments last year for its primary dealers to boost secondary market liquidity, in another step to emulate sovereign issuers.

But the single biggest development for the EU in becoming a sovereign issuer in the capital markets is the inclusion of its bonds in sovereign bond indexes. This is the official classification in bond markets and will subsequently allow government bond investors to purchase and add EU bonds to their portfolios, boosting both the demand and liquidity of EU bonds.

Over the last year, the EU has been reaching out to index providers to include their bonds in government bond indexes and now this process is ‘getting traction’, observed Hahn. ‘Recently, a leading bond index provider has launched a consultation process proposing to add EU bonds to the definition of sovereign bonds.’ He said the consultation started in April and will run until the end of June when a decision will be announced.

Should the inclusion go ahead, others will surely follow, pushing EU bonds into being seen unanimously as a sovereign in the capital markets. The first major index provider considering adding EU bonds to its sovereign index is understood to be Intercontinental Exchange. The outcome of its consultation is expected to be released in August.

The results of the Commission’s inaugural EU bond investor survey, published last September, found that the inclusion of EU bonds in sovereign indexes was the most important remaining step to align them further with European government bond markets, with 75% of respondents saying this was of strong importance. About two-third of investors in the survey said they would increase their exposure to European debt if EU bonds were to be included in sovereign indexes.

Since the EU’s inception as a large borrower in the capital markets, the closest comparable in the European government bond markets has been France. The spread between EU bonds and French government bonds (OATs) has been narrowing – even reaching as low as 2 basis points last month for the 10-year segment.

This has been seen as a great achievement for the EU, despite EU bonds having a higher rating than France, due to the strong levels of liquidity in OATs as well as the size of that market. Many market participants feel the gap between EU bonds and OATs has been narrowing due to the expectation of EU bonds being included in sovereign bond indexes and that such inclusion will result in the EU trading through France.

The appeal of EU bonds is its triple-A status and the strong guarantee underpinned by EU member states, contributing to the pool of safe assets in Europe and the international role of the euro. The size of outstanding debt by the four biggest supranationals (EU, European Investment Bank, European Stability Mechanism, European Financial Stability Facility) is due to extend beyond €1tn for the first time this year with total outstanding EU bonds set to surpass €500bn in 2024 and €1tn by the end of 2026.

The EU is also on track to becoming the world’s largest issuer of green bonds, with 30% of the funding for its Next Generation EU programme coming in the form of green-labelled debt. As the EU has developed its borrowing programme, its investor base has grown to over 1,700 investors from across 70 countries.

In addition to potential inclusion in government bond indexes, the EU is expected to make a number of other significant developments this year on its journey towards sovereign status, including the creation of a repurchasing facility in the summer. 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.