Do EU SURE and NGEU bonds contribute to financial integration?

Prepared by Alexandra Born, Claudia Lambert, Luis Molestina Vivar, Andrzej Sowiński, Josep Maria Vendrell Simon

Published as part of the Financial Integration and Structure in the Euro Area 2024

Over the period 2024-26, the European Commission will become the largest net issuer of euro-denominated securities with the issuance of bonds under the temporary Support to mitigate Unemployment Risks in an Emergency (SURE) and Next Generation EU (NGEU) programmes. To counter the negative economic and social consequences of the COVID-19 pandemic in Europe, the EU Council adopted two programmes to issue common EU bonds. The first was SURE, an EU programme to finance short-term employment schemes, with a view to helping Member States cope with sudden increases in public expenditure to preserve employment. This was followed by NGEU, which aimed at putting Member States on a path towards a sustainable recovery and a greener, more digital and more resilient Europe. In total, the European Commission had issued around €100 billion of SURE bonds by the end of 2022, when the programme ended, while the total issuance of NGEU bonds will amount to €806.9 billion over the period 2021-26, with €306 billion having already been issued by the end of 2023. This will render the Commission the largest net issuer of euro-denominated securities and result in the largest supranational stock of EU bonds in the history of the EU, akin to that of a medium-sized euro area sovereign.^[1] In addition, EU bond issuance will increase the Aaa-rated segment of euro area government and supranational bonds by almost 40% (Chart A, panel a).

The issuance of these temporary recovery instruments has renewed the discussion on the benefits of a common safe asset and their transformative potential for EU financial integration. Given that a common safe asset may foster financial integration in the euro area by facilitating diversification and de-risking banks’ sovereign portfolios, this box assesses the extent to which these newly issued EU bonds (i) are perceived by market participants as a common safe asset, and (ii) can facilitate diversification and affect banks’ sovereign portfolio composition.^[2]

Chart A

Total SURE and NGEU bond issuances will increase the Aaa-rated segment of euro area government bonds substantially, but they continue to trade at a discount compared with euro area government bonds with similar or even slightly lower ratings

a) Outstanding general government debt securities	b) Yield curve for EU, DE, FR and EIB bonds
(USD trillions; Q2 2023)	(percentages; 15 May 2024)

While EU bonds fulfil most of the criteria to be a safe asset, market participants still consider them to be more like those of other supranational issuers than the highest quality bonds of euro area sovereign issuers.^[3] A safe asset should be of a high credit quality, retain its value in the event of market stress and have a liquid market. Despite the high rating assigned to EU bonds (substantially above the average rating of EU Member States weighted by the nominal amount of debt outstanding) for a number of maturities, they trade at a discount compared with euro area government bonds with similar or even slightly lower ratings (Chart A, panel b).^[4] In addition, EU bonds are typically priced off the swap curve, a pricing characteristic more common for supranational bonds than for European government bonds (EGBs).

EU bonds have had a commendable track record in risk-hedging, but they remain less liquid than euro area sovereign bonds of the highest quality. During the US and Swiss banking stress episodes in March 2023, EU bonds remained highly correlated with German bonds. The EU-DE spread widened only temporarily, with correlation levels remaining consistently high (Chart B, panel a). While spreads for EU bonds correlate positively with interest rates’ implied volatility, they show no such correlation with equity implied volatility, which is more often seen as a gauge of market stress. However, although the liquidity of EU bonds has improved substantially, it remains lower compared with that of the safest euro-denominated sovereign bonds, such as those issued by Germany (Chart B, panel b). According to Bloomberg data, the most common liquidity indicators, such as bid-ask spreads, suggest the transaction costs are still higher than those of the highest quality EGBs, which might partly explain why EU bonds trade at a discount. While EU bonds are available on multiple trading platforms, also for repo trading, they are used almost entirely in overnight transactions, indicating a limited role in actively supporting trading, and instead rather serving funding purposes.^[5] Several factors might adversely impact the liquidity of EU bonds, including the growing, but still low, free float, limited participation in bond indices (confined to supranationals) and a lack of derivative contracts referencing EU bonds.

Chart B

EU bonds are highly correlated with German sovereign bonds and also appreciated during the March 2023 banking stress episodes, but scarcer liquidity might be a key risk premia factor

a) Spread and correlation for 2032 EU and DE bonds during March 2023 banking stress	b) Composite liquidity indicator for EU bonds and of selected euro area countries
(left-hand scale: basis points; right-hand scale: correlation coefficient; 1-31 Mar. 2023)	(Bloomberg LQA liquidity score; Dec. 2022-May 2024)

To foster the development of the EU bonds ecosystem, the European Commission and the ECB have taken a number of strategic actions. The Commission has established an incentivisation scheme for primary dealers aimed at reducing trade execution uncertainty. Other initiatives include the introduction of a repo facility, anticipated in mid-2024, and the launch of the EU Issuance Service (EIS) in January 2024, facilitating full integration into the Eurosystem payments and settlement infrastructure. An investor survey to gauge perspectives on features that would align EU bonds more closely with EGBs has already been completed.^[6] In addition, since 29 June 2023 the ECB’s collateral treatment of EU bonds has been the same as for central government bonds, classifying them as Level 1 high-quality liquid assets for banks’ liquidity coverage ratio calculations.^[7] Additionally, EU bonds can be used as collateral with various central counterparties, such as Eurex and LCH.

EU bonds tend to have a diversified investor base, with banks being the largest euro area sector investing in these bonds. Around one-third of EU bonds are held by euro area sectors excluding the Eurosystem. Focusing on these euro area investors, they are located across various countries, with investors in Germany, France and the Netherlands holding the largest amounts (Chart C). The euro area banking sector is the largest sector investing in EU bonds, holding nearly 45% of the total euro area holdings of these bonds.

Chart C

Newly issued SURE and NGEU bonds have a diversified euro area investor base, while the banking sector has the highest exposure to these bonds

(percentages; Q2 2023)

To date, euro area banks’ EU bond holdings are small relative to their domestic government bond holdings, although there is substantial heterogeneity across countries. German banks hold the largest amount of EU bonds among the euro area banking sectors, followed by France, the Netherlands, Italy and Spain (Chart D). The share of EU bond exposures relative to domestic government bond holdings is relatively low in most euro area banking sectors, with a euro area average of 10%. Notably, the share of EU bonds in banks’ portfolios relative to domestic sovereign bonds is higher in the Netherlands and in Luxembourg, relative to other euro area banking sectors. While Dutch banks invest a considerable amount in EU bonds relative to other euro area banking sectors, the high share of EU bonds in Luxembourgish banks’ portfolios is driven largely by their relatively small holdings of domestic sovereign bonds.

Chart D

In most countries, euro area banks’ EU bond (SURE and NGEU) holdings are small relative to domestic government bond holdings, although there is substantial heterogeneity across countries

(Q2 2023)

While EU bonds fulfil most of the criteria to be a common safe asset, it has so far been difficult to fully exploit their associated potential benefits. EU bonds are of a high credit quality and have had a good track record in risk-hedging during recent market stress events. However, they are less liquid than high-quality euro-denominated sovereign bonds. The temporary nature of EU bonds seems to be one of the biggest hurdles. Market participants still consider EU bonds to be more like those of supranational issuers than those of euro area sovereign issuers, despite a number of actions taken to further develop the EU bond ecosystem. Other factors that could boost the status of EU bonds include their inclusion in EGB indices and potentially also futures contracts on EU bonds – though this is outside of the European Commission’s control. A more general discussion about the future of EU bonds may be important, as market participants’ investment decisions could be heavily impacted by issues regarding the certainty and general perception of this project. In terms of EU bonds’ impact on financial integration, the evidence is not conclusive. Initial data on banks’ holdings of these bonds suggest limited diversification relative to domestic government bond holdings in most countries, but these results are only indicative given the limited amount of EU bonds that have been issued at this point. More analysis is needed once the issuance of EU bonds reaches a more sizeable level.