Sovereign Index Inclusion Could Revolutionize EU Bonds

The European Union’s aspirations for inclusion in sovereign bond indices face renewed hope despite earlier disappointments when leading index providers Intercontinental Exchange (ICE) and MSCI opted not to add the EU to their government bond indices. Achieving sovereign index status by 2025 could dramatically impact the EU’s bond market, attracting global investors and enhancing demand, performance, and liquidity.

“Being included in an index would be a major game-changer,” stated an investor at the summit in Singapore. “Such inclusion would make our investments in EU bonds more structural rather than opportunistic.”

Investors view EU bonds as a “spread product,” similar to other supranational issuers, rather than as sovereign benchmarks. Investors often buy EU bonds based on their relative value compared to peers or for additional yield over other European government bonds.

Achieving sovereign index status would shift this perspective. “Index inclusion would fundamentally alter the demand dynamics for EU bonds,” explained another investor at the summit. Inclusion would assign the EU bonds a specific weighting in the index, leading investors who align their portfolios with the index to also gain exposure to EU bonds. This change would also attract investors who exclusively focus on government bonds.

Even without sovereign index inclusion, signs show that the EU is emerging as a rates product. Some bank treasuries have already begun incorporating EU bonds into their portfolios. The bonds are performing well, often surpassing French bonds across most of the yield curve, partly due to recent political and fiscal uncertainties in France.

Sovereign Index Inclusion Could Revolutionize EU Bonds

As the fifth largest issuer in Europe, following Germany, Italy, France, and Spain, the EU has become a significant player in capital markets. The introduction of the NextGenerationEU (NGEU) bond program highlighted the growing importance of EU bonds. “With a global shortage of triple-A assets, this program will likely create a new major asset class for global investors,” noted one investor. “Assets exceeding half a trillion dollars become essential to investment strategies.”

The EU has not yet reached the trillion-dollar mark but is set to surpass €500 billion in outstanding bonds by the end of 2024 and aims to hit €1 trillion by 2026. While the future beyond 2026 remains uncertain with potential changes in NGEU funding, the expectation is that the EU will continue to be a significant borrower in capital markets.

To secure and sustain its place in sovereign indices, the EU needs to improve liquidity across its bond curve. A credible, safe asset must demonstrate low credit risk and strong liquidity. Key developments include the forthcoming launch of the EU’s repo facility, the establishing of a futures market, and ongoing outreach to global investors.

The summit in Singapore was part of a series of events to examine the evolution of EU bonds into a global benchmark. Previous discussions in Dubai and Singapore have brought together the European Commission with leading investors from the Middle East and Asia, respectively.

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