Stability Bonds Offer Some Hope For the Eurozone But Moral Hazard Remains Top of Mind for Investors, Says Poll of Investment Professionals

Within the context of the European Commission’s consultation on the issuance of "Stability Bonds" as a solution to the eurozone sovereign debt crisis, a CFA Institute poll of investment professionals in the EU and Switzerland reveals that their common issuance could help alleviate the debt crisis, but only as part of a package of structural reforms, fiscal integration, and a strong common governance framework.

Regarded as a potential instrument to address liquidity restraints in euro area Member States and as a mechanism for reinforcing financial stability in the euro area, Stability Bonds raise a number of interesting issues for investors and questions for capital markets. The poll, which generated feedback from 798 members, was conducted in order to inform the CFA Institute response to the European Commission’s Green Paper on the feasibility of introducing Stability Bonds and provide feedback on the concerns of professional investors.

Comprising market practitioners and investors, CFA Institute members were asked to express their opinion on the structural options for the bonds, and the pre-conditions to their issuance. The survey generated the following key results:

• The majority of respondents agree that the common issuance of Stability Bonds among euro area Member States would alleviate the sovereign debt crisis (55 percent), reinforce financial stability in the euro area (52 percent), and facilitate the transmission of euro area monetary policy (56 percent).
• Joint and several guarantees would be the most effective approach for the common issuance of Stability Bonds among Member States of the euro area, according to 64 percent of members.
• A partial substitution of Stability Bond issuance for national issuance, in which a portion of government financing needs would be covered by Stability Bonds, with the rest covered by national sovereign bonds, is supported by 64 percent of members.

The risk of moral hazard, where some Member States may follow poor budgetary discipline with limited implications for their financing costs, is a key concern of CFA Institute members. Consequently they view the following as necessary preconditions for participating Member States:

• Significant enhancement of economic, financial, and political integration (supported by 86 percent).
• Increased surveillance and intrusiveness in the design and implementation of national fiscal policies (supported by 88 percent).
• Limited access to the Stability Bonds in cases of non-compliance with a euro-area governance framework (supported by 90 percent).

Commenting on the poll, Agnès Le Thiec, CFA, director, Capital Markets Policy, CFA Institute, said: “A majority of our members believe the common issuance of Stability Bonds could help solve the debt crisis in the eurozone. However, new financial instruments will not cure the structural problems of imbalances in trade and competitiveness, or public debt, in many Member States. Stability Bonds also carry a high risk of moral hazard, and would therefore have to be associated with much more extensive structural reforms, fiscal integration and a strong common governance network.”

Nitin Mehta, CFA, managing director for the EMEA region at CFA Institute commented: "The Green Paper on Stability Bonds, published by the European Commission, initiated an interesting and important debate about how joint issuance of European debt might help to calm financial markets. Clearly, the success of the proposal would hinge critically on the attitude of investors. Our survey sought to test their opinions and thereby better inform policy makers, and the feedback we received reflected diverse views but also some clear results. These should be of considerable interest to the European Commission, as well as market participants and other interested constituencies."