Sept 07 - The European Central Bank has addressed a significant concern regarding its intervention in eurozone sovereign bond markets by renouncing any claim to seniority over private sector creditors in its new bond buying programme, Fitch Ratings says.
ECB President Mario Draghi said Thursday that the Eurosystem expects pari passu treatment with private creditors regarding bonds bought via Outright Monetary Transactions (OMTs).
As we said in a special report, Sovereign Rating Implications of External Support, Bond Purchases and Seniority, published 24 August, the de facto seniority of the ECB, shown in its exclusion from the Greek government bond restructuring in April, threatened to compromise the potential positive impact of bond purchases by increasing the risk premium that private investors demand for their implied subordination.
The ECB will consider OMTs for countries that request support from the European Financial Stability Facility /European Stability Mechanism (EFSF/ESM) and sign up to the accompanying programmes, Draghi said. Bond buying will be subject to “strict and effective conditionality” and will cease if there is “non-compliance with the macroeconomic adjustment or precautionary programme.”
In announcing that the Eurosystem “intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors? in accordance with the terms of such bonds,” the ECB should have helped address subordination concerns. However, the ESM in its current form will enjoy explicit seniority over private creditors, so a combination of ESM and ECB support would still imply some subordination of existing creditors.
OMTs should help reduce the risk of self-fulfilling liquidity crises, which would be credit positive for the affected sovereign, although as we said in August, a key consideration is whether official intervention signalled a loss of market access. If so, the implied loss of financing flexibility and reliance on policy-conditional funding would not be consistent with a rating above the ‘BBB’ category unless this situation was judged to be short-lived. We would determine the credit and rating implications of financial support for eurozone sovereigns on a case-by-case basis.
As we have previously said, in the case of Spain, a request for EFSF/ESM support, especially if supported by secondary market purchases by the ECB, would significantly reduce the risk of a self-fulfilling liquidity crisis and help the Spanish government retain access to affordable market financing. As such it would not prompt a negative rating action from Fitch.
OMTs may also be considered “for member states currently under a macroeconomic adjustment programme when they will be regaining bond market access.” As such, the programme could help smooth the re-entry of Ireland back into the bond market - a process that has begun with bill and bond sales this summer.
While a positive move, ultimately the stabilisation of eurozone sovereign ratings will hinge on the success of the kind of economic and fiscal adjustment programmes that OMT purchases will be tied to.
The ECB’s existing sovereign bond buying programme, the Securities Market Programme (SMP), has been terminated, and bonds bought under the SMP will be held to maturity with their creditor status unaltered, Draghi said.