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Treasury & Capital Markets / Europe
EU still excluded from MSCI bond indexes
Just because EU-Bonds look like sovereign bonds doesn’t mean they are; all eyes on ICE
Keith Mullin 17 Jun 2024

In April 2023, in a column on this platform about the EU’s call to be treated as a composite sovereign nation rather than a supranational (Is the EU a sovereign?) I concluded that that was a conceptual stretch for debt investors for a whole bunch of political and structural reasons. MSCI has just come to the same conclusion.

That’s despite the fact that EU officials had gone and continue to go to great lengths to make their bonds more sovereign-like. Like branding them as “EU-Bonds”. Like allocating bond proceeds from centralized cash pools. Like (other than for ESG labelled instruments) not pre-announcing specific use of proceeds for each bond at the start of marketing. Or like having EU-Bonds upgraded to haircut category I, the same as sovereign bonds, for collateral purposes in European Central Bank monetary policy operations.

With all of that, EU-Bonds have yet to attain status as a risk-free global safe asset. The problem it has is one of form over substance. Just because your bonds look like sovereign bonds doesn’t mean they are sovereign bonds. Being classified as a supranational, the lack of an EU-Bond future, the lack of a permanent or a joint borrowing mandate, the lack of fiscal autonomy, and exclusion from government bond indexes are still factors that force its debt to price and trade rich to German government bonds. That drives EU funding officials and policy makers bananas.

Well, MSCI announced on June 12th that EU-Bonds will remain ineligible for the standard suite of its Government Bond Indexes. It came to that conclusion after disagreements among investors in its consultation that just ended (a “bifurcation of opinion within the investment community” in the rather quaint wording of MSCI’s short statement).

The index provider said it remains committed to closely monitoring the market's adoption of EU-Bonds within the government bonds space and intends to re-evaluate the eligibility criteria in the second quarter of 2025. In the immediate aftermath of the MSCI decision, EU-Bonds underperformed sovereign peers as investors – presumably those that thought MSCI would announce that EU-Bonds would become index eligible and got in ahead of the decision – backed out of trades.

Since the bloc massively ramped up its debt issuance in the wake of the pandemic-induced economic crisis in 2020, it has issued over €371 billion (US$ 396.93 billion) to fund economic recovery and other programmes (like funding for Ukraine). Its debt has attracted demand of almost €3 trillion, investors attracted by the juicy spread over German government bonds. So far this year, the EU has issued €42 billion in new syndicated bonds and re-openings.

Altogether, MCSI noted that there are roughly €467 billion of index-eligible EU-Bonds outstanding. If they were included, it would result in a weighting of approximately 5% in the MSCI Eurozone Government Bond Index and 1.5% in the Developed Market Government Bond Index. MCSI’s decision followed a consultation that opened in May, which asked some very simple questions without any political pre-amble or intent:

  • Should EU-Bonds be eligible for inclusion in MSCI Government Bond Indexes and, if so, when (September, October or November month-end rebalancing)?
  • If eligible, should EU-Bonds be phased in – no (all bonds to be included at once), over two months or over three months?
  • Should EU-Bonds continued to be classified as supranational bonds? Or since the European Commission is domiciled in Brussels, should the country of risk for the EU-Bonds transition to Belgium?

(On a side note, re-domiciling what will be closer to €1 trillion of EU-Bonds by 2026 as Belgian debt is an intriguing idea that I’d love to see that being attempted.)

The MSCI move will have been a blow to EU officials, who have been lobbying government bond index providers hard. Only last month, the OMFIF Sovereign Debt Institute reported that Johannes Hahn, European commissioner for budget and administration, had told its EU-Bonds summit in Dubai that the EU is “growing out of the sovereign, supranational and agency market into the market of sovereign bonds”. Not quickly enough, it would appear.

A fundamental problem for the EU is that even though its debt pile and current funding programme are certainly sovereign-like in size, the mammoth NextGenEU funding programme comes to an end in 2027. After that, there is no clarity around whether it will be extended or superseded by another funding programme. That’s distinctly un-sovereign-like. Without borrowing permanence, there are concerns about the liquidity profile of what will effectively become orphaned bonds. EU funding after the programme officially ends will be restricted to refinancing maturing debt.

With MSCI having made its decision until it next considers the topic in 2025, all eyes now are on the Intercontinental Exchange (ICE), which is consulting on the same thing and will announce its decision in August, according to media reports. Time to get those shorts on?

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