The EU's Ascent to Sovereign Bond Index Inclusion: A Game-Changer for Global Investors

The European Union has faced a setback earlier this year when both Intercontinental Exchange (ICE) and MSCI declined to add the EU to their government bond indices. However, there is hope that the EU will still achieve sovereign index inclusion sooner rather than later – perhaps as early as 2025. Such a move would have a significant impact on the EU's bonds, making them attractive to global investors and increasing their demand, performance, and liquidity.

Unlocking the EU's Potential as a Sovereign Bond Powerhouse

Transforming the EU's Bond Status

At present, the EU is largely viewed by investors as a "spread product," meaning it is treated as a typical supranational issuer rather than a sovereign or a benchmark for European bonds. Most fixed-income investors buy EU bonds on a relative value basis versus their peers or for a pick-up to other European government bonds. However, inclusion in sovereign indices would completely invert this dynamic. If the EU joins a government bond index, it will have a certain weighting of bonds held in that index, and investors who link their portfolios to that index will also have the same exposure. This would open up the possibility for other investors who only buy government bonds to start investing in EU bonds, significantly increasing the structural demand for the asset class.

The Significance of Index Inclusion

The major game-changer for the EU's bonds will be index inclusion, according to an investor at the OMFIF-EU bonds summit in Singapore. If the EU is included in an index, then investments in EU bonds could become more structural rather than opportunistic. Sovereign index inclusion will also allow the EU to be treated as a rates product, rather than just a spread product, as some investors are already starting to do, including bank treasuries who are beginning to place EU bonds in their European government bond portfolios.

The EU's Growing Prominence in Capital Markets

The sheer size of the EU as the fifth-largest issuer in Europe has turned it into a significant component in capital markets, behind only Germany, Italy, France, and Spain. With the announcement of the NextGen (NGEU) bond program, the basic conclusion reached was that given the shortage of triple-A assets in the world, this would lead to the evolution of one more asset class that would become really relevant for global investors. In any asset class, if it crosses half a trillion in size, it starts to become a real part of an asset allocation strategy.

The EU's Path to Sovereign Index Inclusion

The EU is not quite at a trillion in size yet, but it is moving in that direction with total outstanding EU bonds set to surpass €500bn by the end of 2024 and €1tn by the end of 2026. There is some uncertainty about what lies beyond 2026 when the NGEU funding will end, but the expectation is that the EU will remain a permanently large borrower in capital markets.To convince market participants and investors that it deserves its place in sovereign indexes, the EU needs to continue to improve liquidity across the curve. A safe asset does not only need to have low credit risk, but it must also have strong liquidity. The upcoming launch of the EU's repo facility will be an important development, as well as the establishment of a futures market and continued outreach and dialogue with global investors.

The EU's Bonds Summit: Fostering Global Investor Engagement

The OMFIF-EU bonds summit in Singapore formed the second part of a special series of events for investors to better understand how EU bonds are developing into a global benchmark and safe asset in capital markets. The first event took place in Dubai on 1 May, bringing together the European Commission with leading investors in the Middle East, while the second event took place on 10 September with leading investors in Asia. These events aim to facilitate a deeper understanding of the EU's bond market and its potential as a sovereign asset class.