Sub-Sovereign Bonds

Types of Bonds

Sub-Sovereign Bonds

The Sub-Sovereign Bond Market is defined first as any level of government below the national or central government, which includes regions, provinces, states, municipalities, etc. that issues bonds. In Europe, the sub-sovereign market is primarily one dominated by agencies and supranational institutions such as the World Bank, KfW and the European Investment Bank (EIB). As European countries have increasingly become one market, the growth of the sub-sovereign bond market has been significant as well.

Growth in the number and amount of sub-sovereign entities issuing debt has been related to changes in the structure and function of government entities below the national or “sovereign” level. Re-examination and reorganisation of sources of revenue for sub-sovereign entities and access to capital for new infrastructure are important topics in Europe, as the European Union continues to expand and develop rule on what categories of sub sovereign government borrowing are included in the national debt ceilings and which are excluded. Although central governments in Europe have been more likely to issue bonds than sub-sovereign entities in Europe, sub-sovereign entity participation in the bond markets is expanding dramatically in part because effective government needs to finance day to day operations of public services and capital infrastructure investments in roads, hospitals, bridges, reservoirs and other infrastructure at the same time as sovereign governments have debt ceiling limits. Government and sub-sovereign bond markets thus exist side by side as different and serve as independent sources of financing for the national or central government as well as for the local governments.

The market for sub-sovereign bonds in Europe has less individual participation than in the US; individual investors in the US municipal bond market also enjoy significant tax advantages for their investments. However, there are certain countries in Europe such as Germany in which individual investors are more inclined to participate in the sub-sovereign debt market.

Sub-sovereign bonds can also be a way to support innovations in the availability of types of financing to meet local or regional needs. For example, the first bond issuance in Europe that was designed under Islamic principles called Sukuk was a sub-sovereign bond issue in Germany that did not offer interest payments but instead provided the bond’s investors a return equal to EURIBOR rates.

Some functions in the economy are not a central government’s direct responsibility, but the government needs and wants to develop and strengthen the way those fields function. The most common fields on which government focuses such attention are mortgage loans to strengthen affordable housing, loans to students for educational purposes, loans to farms or small businesses, etc. To finance these efforts, a central government may create something called a government agency and finance this quasi-government agency by issuing bonds. Since they are indirectly or directly guaranteed by the government, these bonds are called quasi-government or sub-sovereign or agency bonds. Such agencies can be publicly or privately owned. For example, the German government guarantees bonds issues by the agency KfW which makes housing and small business development loans. The US government has a mixed strategy, guaranteeing some mortgage bonds (Ginnie Mae) and not others (Fannie Mae and Freddie Mac).

All entities that issue sub-sovereign debt are rated by credit agencies on credit worthiness and soundness criteria. Some sub-sovereign bonds are rated almost as high as the highest rated government bonds, but not always, because underlying characteristics of the issuers are not likely to be identical.

Sub-sovereign bonds are subject to an array of national and regional provisions in Europe and in the European country of origin and may have tax implications. Consult your bank or broker for more information on investing in sub-sovereign bonds; and your tax advisor or country’s tax authority for information on the tax requirements related to such investments.

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