A proposal from Finnish prime minister Jyrki Katainen that vulnerable euro-zone sovereigns issue covered bonds to ease market access has met with deep scepticism, but an agreement reached by leaders at an EU summit last night lifted markets.

Finnish PM Jykri Katainen

The agreement paves the way for the bail-out of Spanish banks on terms sought by the country, while boosting support for peripheral government bond markets and showing flexibility with regard to the conditions put on countries. Yields on benchmark Italian and Spanish government bonds fell sharply this (Friday) morning while equities rallied.

The Finnish proposal yesterday (Thursday) called for countries to issue covered bonds backed by government assets or tax revenues, with Katinen saying that Finland had done likewise in a difficult economic situation in the 1990s.

It was not clear what issuance the politician was referring to, although Finland did in 1995 launch what is said to be the first ever government securitisation. This was a securitisation by the Housing Fund of Finland of social housing loans under a programme called Fennica. However, the goal of that transaction was to remove liabilities from the Finnish government’s balance sheet as it sought to meet euro entry criteria after having suffered a recession in the early 1990s.

Katinen is reported to have said that countries including Spain and Italy had properties available that could secure covered bonds, but covered bond bankers – who found it hard to take the proposal seriously – said that finding appropriate collateral would be difficult.

“How is this supposed to work?” asked one. “You can’t sell the parliament so, to take an extreme example, let’s assume the state defaults and an administrator or investor is left with a parliament building, what can be done with it? The state can’t buy it back because it doesn’t have any money.”

He said that other assets were also problematic, questioning whether investors would want to gain exposure to real estate in such countries when they had already proven unwilling to invest in private bond issues backed by such collateral.

Bankers meanwhile said that shares in state enterprises and infrastructure would, if attractive to investors, be more sensibly sold.

Any such covered bonds would also face legal and market issues related to subordination, with negative pledge clauses present in some outstanding government bonds and the subordination of existing bondholders potentially depressing bond prices. A plan for the Greek government pledge collateral to the Finns in return for their share of bail-out funds had to go back to the drawing board when similar issues arose last year and the final details of an alternative, indirect arrangement were not made public.