The ECB’s statement in early November to the financial markets regarding the eligibility of repo collateral of sovereign debt has caused some heated discussion in the higher echelons of European finance policy makers, especially those in Portugal, Italy and Greece.
In answer to a question at a press conference ECB governor Jean-Claude Trichet said that the ECB would not accept collateral with a rating lower than A–. Currently only Greece is anywhere near this level (A). This change brought the ECB’s policy in line with regulators in the UK, Sweden and Switzerland. However the ECB is the central bank not of a nation state but of a new political union. The timing of its announcement resulted in the issue price of a five-year bond from Portugal widening by 1bp from 10bp over treasuries on the $3billion deal. That cost Portuguese tax payers some €900,000 extra upfront.
What game is the ECB playing? Until this clarification, the bond markets had assumed that the ECB would apply the same rules to all eurozone sovereign debt, regardless of rating. While the ECB takes liquidity into account in discounting bonds for repo, it does not look at credit.