After six years of telling retail investors that Greece’s junk-rated debt is as safe as its own AAA bonds, Denmark is finally admitting that’s not the case.
A government working group is now recommending that banks make clear to their clients that holding Greek sovereign bonds comes with risks. Denmark’s Business Ministry will have the final word before the proposal can be adopted.
“We’ve been struggling with this problem,” Ulla Petersen, acting director for the Danish Financial Supervisory Authority’s consumer unit, said in a phone interview. “Real life” has proven that “you can’t call them a very safe product.”
Denmark has been one of the most vocal critics of a global regulatory framework that gives all government bonds a risk-free status. It fought, and prevailed against, a Basel III rule that would have assigned its AAA mortgage-backed covered bonds a much lower liquidity ranking than Greek government debt.
“This was a big issue with the liquidity coverage ratio discussion, despite their actual performance,” Jesper Berg, head of regulation at Nykredit Realkredit A/S in Copenhagen, said by phone. “It makes sense to start to differentiate between different government bonds.”
The yield on Greece’s benchmark 10-year bond topped 13 percent last month, while similar-maturity Danish debt yields less than 1 percent. Danish mortgage bonds with 10 years left until maturity yield less than 3 percent, according to data compiled by Bloomberg.
Regulators are still grappling with the question of how to treat sovereign bonds after Europe’s debt crisis made clear the securities don’t always live up to the risk-free designation they enjoy. The European Systemic Risk Board acknowledged in March that some government debt markets “can no longer be regarded as having zero credit risk,” a development Denmark’s central bank said in April it welcomed as “positive.”
Regulators globally are stepping up efforts to protect retail investors, with Europe implementing new disclosure and sales requirements due to take force by 2017. Last year, financial watchdogs in the U.K. and the European Union warned banks against selling contingent convertible bank debt to retail investors.
Denmark uses a so-called traffic light system to help retail investors identify risky products. Back in 2009 when the model was implemented, Danish government bonds and all euro-denominated sovereign debt were given a green designation, indicating the securities are almost risk-free.
But as Greece teeters on the brink of default, the Danish working group says it’s time to change the traffic-light system. Specifically, the group says all euro-zone bonds issued by governments with 110 percent or more in debt to gross domestic product should be bumped down a notch, to yellow. The proposal means that bonds sold by Portugal and Italy would also be downgraded.
Better late than never, said Jens Nielsen, director of the Danish Shareholders Association. He applauds Denmark’s plan to make its traffic-light system “more nuanced.” Though a “fine idea,” the 2009 framework unfortunately resulted in the “absurd” situation that gave Greek bonds the highest rating, Nielsen said.
“This has been a soft spot in the regulation since it came out,” Petersen at the FSA said. When it was originally adopted, “people didn’t expect a euro country to fail.”
Petersen said the proposed change follows a barrage of complaints from the investment community and academics, who argued that the existing model doesn’t reflect reality.
After the changes, the system will “reflect the extra risks of these government bonds,” she said. “If the Greek or Portuguese government were to complain, we could defend our case.”