The first European Secured Note is on its way, after more than a decade of debate. Although it mimics the structure of covered bonds issued by banks, the issuer paving the way is French agency Bpifrance.
But despite being designed on the template of covered bonds, the regulatory treatment of ESNs is quite different.
The idea grew out of the European Union's Capital Markets Union drive — to create a version of covered bonds to finance assets other than mortgages and loans to public sector entities.
This would be particularly useful for funding loans to small and medium-sized enterprises, policymakers thought.
The European Covered Bond Council took up the torch and set up a working group to draft a standard.
An ESN is essentially a structured covered bond. It is collateralised by a pool of assets, with investors having a claim against both the collateral and the issuer.
However, the collateral can be much more varied. Bpifrance's €2bn ESN programme is secured on high quality loans to SMEs and mid-cap companies in France.
Issuing such a deal makes sense for Bpifrance. The ESNs will be rated Aaa, three notches above the issuer's Aa3 rating.
Researchers at Barclays expect its first deal to be priced 5bp-6bp inside where the agency’s unsecured debt might be priced. That is a big enough gap to make a difference to the SME borrowers, if Bpifrance passes on the benefit.
However, this new product is a regulatory waif.
Despite having conceived it, the European authorities have never recognised their offspring.
The European Bank Authority examined the product's viability in 2018 and 2025, but chose not to provide guidance. ESNs therefore have no regulatory status.
Consequently, they also lack all the regulatory perks that covered bonds enjoy. Legislative covered bonds secured on mortgages below a certain loan to value ratio that are regularly valued, or on guaranteed public sector loans, get preferential risk weightings for bank investors under Article 129 of the EU Capital Requirements Regulation.
Researchers expect Bpifrance's ESNs to have a 20% risk weighting under the standardised approach, thanks their expected triple-A rating.
Although this is better than the 30% afforded to Bpifrance’s senior unsecured bonds, it is still higher than the 10% a typical CRR-compliant legislative covered deal might achieve.
On top of this, analysts believe the Bpifrance ESN will probably not be treated as liquid assets for banks' Liquidity Coverage Ratios, nor will they be eligible for repo with the Eurosystem central banks.
Unsurprisingly, this will reduce investors' enthusiasm, pushing up the cost of issuing this supposedly cheaper form of debt.
And although this secured debt might come out slightly cheaper than unsecured, its pathway to wider adoption is strewn with obstacles.
Europe's banks and political leaders are united in wanting to use the financial system more effectively to support economic growth.
ESNs were dreamt up as a way to funnel cheaper funding to parts of the economy untouched by traditional covered bonds.
If they were an idea whose time had come 10 years ago, putting that idea into practice is now overdue.
The first issue will be a test flight. European regulators would be wise to watch the outcome carefully.
If demand is high and execution strong, they must create a regulatory regime to ensure this market takes wing.