This week the European Banking Authority published its final report on ESNs, an untested dual recourse product designed to fund Europe’s small and medium-sized enterprises.
As SMEs are Europe’s biggest creators of jobs, the ESN concept curried much favour with the European Commission in its efforts to form a Capital Markets Union.
But whether the ESN actually becomes anything other than a niche product used by anyone other than smaller Italian banks for repo purposes, or one French agency, remains to be seen.
The genesis for the ESN was Commerzbank’s SME-backed deal issued five years ago.
Much to the chagrin of market purists, Commerzbank had the temerity to call it a covered bond, though it was priced mid-way between the issuer’s senior unsecured and Pfandbrief curves.
Since then, quantitative easing has crushed the credit curve, and regulators have introduced resolution regimes giving rise to preferred and non-preferred senior unsecured formats.
As a result the ESM pricing paradigm has been muddied and the funding advantage has become less compelling.
From an investor's perspective, the dynamic pool of short dated unsecured loans backing an ESN requires much more vigilance than preferred senior unsecured needs. ESNs pay a lower spread to boot.
The credit work required to invest in an ESN sits more neatly with securitization investors. However, they would rather take the extra spread that a single recourse ABS deal provides.
But if nothing else, ESNs will have served one very useful purpose. By providing an avenue to fund SMEs and other assets, the low risk collateral reserved for traditional covered bonds has effectively been ring-fenced.
Perhaps that was always the plan.