articles Ratings /ratings/en/research/articles/190521-credit-faq-understanding-the-role-of-european-secured-notes-in-funding-sme-and-infrastructure-lending-10987778 content
Log in to other products

Login to Market Intelligence Platform


Looking for more?

Request a Demo

You're one step closer to unlocking our suite of comprehensive and robust tools.

Fill out the form so we can connect you to the right person.

If your company has a current subscription with S&P Global Market Intelligence, you can register as a new user for access to the platform(s) covered by your license at Market Intelligence platform or S&P Capital IQ.

  • First Name*
  • Last Name*
  • Business Email *
  • Phone *
  • Company Name *
  • City *
  • We generated a verification code for you

  • Enter verification Code here*

* Required

In This List

Credit FAQ: Understanding The Role Of European Secured Notes In Funding SME And Infrastructure Lending

Credit FAQ: Understanding The Role Of European Secured Notes In Funding SME And Infrastructure Lending

The European Parliament recently adopted a legislative package introducing a pan-European covered bond framework (see "Harmonization Accomplished: A New European Covered Bond Framework," published April 18, 2019). This initiative is part of the Capital Market Union, a plan to mobilize capital in Europe and provide businesses with a greater choice of funding at lower costs. While the package was positively received, some market participants called it a missed opportunity for introducing ESNs, a dual recourse instrument to support lending to SMEs and infrastructure projects.

This Credit FAQ explains what ESNs are, how S&P Global Ratings would analyze them, and the potential for their future development.

Frequently Asked Questions

What are ESNs?

According to the European Central Bank's survey on the access to finance of enterprises, bank finance remains the main source of funding for SMEs in the region. In order to complement bank financing for SMEs and infrastructure projects with capital market financing, European authorities and market participants are considering the introduction of ESNs: a new debt instrument that would apply some of the basic structural characteristics of covered bonds. Unlike covered bonds, they would be backed by assets such as loans to SMEs or infrastructure lending, which are generally considered riskier than mortgages or public sector loans typically seen in covered bond programs.

Chart 1


While ESNs would constitute a new type of debt issuance, their underlying concept is not entirely new. In 2013, Commerzbank issued a dual-recourse instrument backed by SME loans. These bonds were unregulated and issued on a purely contractual basis. They enjoyed good market reception, but such a deal was not repeated. In 2014, the Banque de France supported the introduction of European Secured Notes Issuer (ESNI), a securitization-like special-purpose vehicle that issues notes backed by collateralized credit claims. In 2016, Italy was the first country to enact primary legislation enabling the issuance of ESN-like bonds: Obbligazioni Bancarie Collateralizzate (OBCs), which may be backed by SME, leasing, factoring, and ship loans, as well as other types of commercial assets. Italian lenders are still waiting for the approval of the secondary legislation and have therefore not been able to test OBCs yet.

Although these instruments have yet to make their full mark on the financial markets, some of their characteristics could be considered in the development of a dedicated ESN framework.

Where do European institutions stand on ESNs?

In its February 2015 Green Paper titled "Building a Capital Markets Union," the European Commission (EC) outlined a plan to complement bank financing with deep and developed capital markets, including for the SME sector, which still has limited access to finance. In response, the European Covered Bond Council, the trade body for covered bonds, proposed to adopt covered bond technology to fund SME loans, and it set up a task force on ESNs. In 2017, the EC commissioned the European Banking Authority (EBA) to undertake feasibility studies into the potential for ESNs. The EC and EBA subsequently published two reports outlining recommendations in 2018.

Chart 2


Whereas the dual-recourse principle is contemplated by both the EC and the EBA for SME loans, there is no consensus for infrastructure loans. Thus, the EBA has suggested a single recourse for infrastructure assets because of their unique risk and large individual exposure, which would therefore rule out ESNs backed by such loans.

ESNs were not included in the final package on the harmonization of EU covered bonds approved by the European Parliament. This was due to the complexity this would have added to the process and the reservations of some countries, which preferred ESNs to be dealt with in a separate initiative. Instead, the Commission has committed to produce a report on the possibility of introducing ESNs within two years of the directive being transposed into national laws, therefore likely by 2023. The Commission will then submit that report to the European Parliament and to the Council, together with a legislative proposal, if appropriate. The adoption of a framework for ESNs, if it occurs, will therefore be years away.

We expect regulators to consider some sort of preferential treatment compared with unsecured bonds under the Liquidity Coverage Ratio and the Solvency II frameworks, but it will probably be less favorable than that for covered bonds due to the riskier nature of assets securing ESNs. Even within ESNs, there may be a regulatory distinction between notes backed by SME loans and those potentially backed by infrastructure loans because of their different risk profiles, with the former asset type more granular than the latter.

How would S&P Global Ratings analyze ESNs?

In order to rate ESNs according to our covered bonds methodology, we will look into the transaction structure to determine whether it is similar enough to what we see in covered bonds, in particular that noteholders have dual recourse to the issuer and the cover pool. If there is no dual recourse, then we will analyze the notes by applying our European SME CLO Methodology And Assumptions criteria (see further details below).

The steps we will take to analyze ESNs will be the same as for covered bonds (see "Covered Bonds Criteria," published Dec. 9, 2014, and "Covered Bond Ratings Framework: Methodology And Assumptions," published June 30, 2015), including:

  • Perform an analysis of issuer-specific factors (legal and regulatory risks and operational and administrative risks) to establish whether a rating on the ESNs may be higher than the rating on the issuer. In particular, we determine whether contractual provisions, the legal framework, or the combination of the two effectively isolate the assets for the benefit of covered bondholders, so that payments on the notes continue on their scheduled dates.
  • Assess the starting point for the rating analysis, based on the relevant resolution regimes. When such regimes are in place, we typically add up to two notches of uplift to the issuer credit rating on the issuer, provided regulators exclude ESNs from the bail-in of financial institutions.
  • Determine the maximum achievable rating on the notes from an analysis of jurisdictional and cover pool-specific factors. We use three factors to assess the likelihood of jurisdictional support, or the likelihood that a covered bond program facing stress would receive support from a government-sponsored initiative. These are: strength of the legal framework; systemic importance of the ESNs in that jurisdiction; and the sovereign's credit capacity. Depending on the outcome of this analysis, we assign up to three more notches of uplift to the notes. We then analyze the collateral securing the ESNs (e.g., SME or infrastructure loans) according to our relevant criteria for each asset type, which can lead to another four notches of uplift unless the ratings on the ESNs are delinked from the rating in the issuing bank (see chart 3 below).
  • Combine the results of the above and incorporate any additional factors, such as counterparty risk and country risk, to assign the final rating on the notes.

Chart 3


For ESNs delinked from the rating on the issuing bank--those which the program structurally has no asset and liability mismatch and the overcollateralization is legally or contractually committed--as with covered bonds, we determine the rating according to whether the available credit enhancement is sufficient to pass our stress scenarios (and we can assign more than four notches of collateral-based uplift).

Unlike covered bonds, which benefit from a long track record and generally enjoy strong or very strong jurisdictional support according to our analysis, ESNs will be at inception an untested instrument. However, if we apply our covered bonds methodology to analyze ESNs, we would likely consider them like any other kind of covered bond when assessing their systemic importance in any given jurisdiction. For example, when covered bonds (including ESNs) account for between 10% and 20% of bank capital market funding or GDP, we typically consider that they benefit from "strong" or "moderate" systemic support; the final systemic support assessment of SME-backed notes will depend on the proportion of SME assets among all asset types securing covered bonds in that jurisdiction. In addition, under our criteria we may change our assessment of systemic importance by one category when we believe other qualitative factors have a material influence, or if we expect a significant change in the systemic importance to occur in the near term.

How would S&P Global Ratings analyze the underlying collateral?

According to our covered bonds methodology, to assess the credit quality of the pledged assets in a cover pool, we generally use the securitization criteria for the type of assets pledged to the covered bond. Therefore, we would apply our "European SME CLO Methodology And Assumptions," published on Jan. 10, 2013, as a starting point to assess the credit risk of SME loans backing a covered bond.

Under this methodology, we use the concept of an "archetypical" European SME pool to which we have assigned an initial average credit quality assessment of 'b+'. The 'b+' calibration is based on three factors: a comparison of European SME performance data and global corporate default data during stressed and benign periods; an analysis of corporate behavior during the Great Depression; and a review of individual European SME obligor quality. This serves as starting point for the default analysis of an actual SME pool in a 'AAA' scenario.

To derive the specific asset default risk for the securitized SME portfolio under a 'AAA' scenario, we adjust the archetypical European SME average 'b+' credit assessment through three steps:

  • Step 1: Adjust the portfolio average credit quality assessment for country and originator by either increasing or decreasing it by up to two notches.
  • Step 2: Adjust the average portfolio credit quality assessment determined in step 1 for portfolio selection bias. This adjustment is either neutral or negative.
  • Step 3: Further adjust for loan quality distribution. This adjustment aims to use the ranking power of the originator's internal scoring tool to distribute obligor rating inputs around the portfolio average credit quality assessment determined under step 1 and step 2.

After applying these adjustments, the portfolio is run in our proprietary credit model CDO Evaluator (publicly available at to calculate the 'AAA' scenario default rate (SDR), which represents the expected amount of defaults on the portfolio in a 'AAA' stress rating scenario (expressed as a percentage). The main drivers of the SDR are the weighted average rating as assessed from steps 1 to 3 above, the diversity (in terms of obligors, industries, and countries), and the weighted-average life of the portfolio.

Subsequently, we derive our assessment of the 'B' SDR for the securitized pool starting from an analysis of the originator-specific default data. We expect these data to be provided in the form of static or dynamic default curves (both cumulative and vintage-specific), which we then analyze together with the securitized pool's weighted average life to form a view on the aggregate defaults that could be expected over the portfolio's life in a 'B' scenario.

Our 'B' scenario is intended to reflect our forward-looking estimate of expected defaults for a portfolio, given the then-current economic trends.

Last, we calibrate the SDRs for rating levels between 'AAA' and 'B' using criteria-specific weights to reflect a geometric progression of default rates across rating categories and the following formula: SDR (Rating) = SDR ('AAA') – Weight x {SDR ('AAA') – SDR ('B')}.

In doing so, we obtain the full range of interpolated SDRs from 'AAA' to 'B' that represent the final output of our credit analysis for the securitized portfolio of SME loans.

We then input the SDR in our cash flow analysis. In accordance with our covered bonds methodology, we also use other inputs, such as the refinancing cost (except for pass-through structures) to produce our target credit enhancement (TCE). Finally, we compare the TCE with the available credit enhancement in the program to determine the maximum achievable covered bond rating.

How successful are ESNs likely to be?

Although the issuance of ESNs would not break intermediation between firms and lenders, it should help reduce borrowing costs for SMEs by plugging them into the financial markets, in the same way as securitization led to lower interest rates on mortgages. Given the crucial role of SMEs in the economies of several European nations and their provision of value-added jobs, we believe there could be a strong regulatory push to establish ESNs as a new source of funding.

Chart 4


From an issuer's perspective, ESNs would enable some small lenders to better access the capital markets, whereas they do not necessarily have access to the securitization market at present. According to the EBA, the size of the ESN market for SMEs could be anywhere between €310 billion and €930 billion, and for infrastructure between €80 billion and €170 billion. Research compiled for the EC report showed muted interest among issuers; however this could easily change with market conditions and, looking further, if a regulatory framework is agreed at a European level.

Investors' interest is more difficult to gauge and will depend on their risk appetite, search for yield, and the regulatory treatment of ESNs. The EC report suggests a stronger interest for ESNs backed by SME loans than infrastructure loans because the perceived complexity of infrastructure loans would make it harder to establish a market price for the corresponding notes.

Related Criteria

  • Covered Bond Ratings Framework: Methodology And Assumptions, June 30, 2015
  • Covered Bonds Criteria, Dec. 9, 2014
  • European SME CLO Methodology And Assumptions, Jan. 10, 2013

Related Research

  • Harmonization Accomplished: A New European Covered Bond Framework, April 18, 2019
  • Global Covered Bond Insights Q1 2019, April 11, 2019
  • Global Covered Bond Characteristics And Rating Summary Q1 2019, April 11, 2019

This report does not constitute a rating action.

Primary Credit Analysts:Tristan Gueranger, CFA, London + 44 20 7176 3628;
Antonio Farina, Madrid (34) 91-788-7226;
Secondary Contacts:Matteo Breviglieri, London (44) 20-7176-8495;
Rebecca Mun, London (44) 20-7176-3613;

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to:

Register with S&P Global Ratings

Register now to access exclusive content, events, tools, and more.

Go Back