ECB could use Steinhoff mess to make necessary changes to bond-buying program

The Steinhoff controversy could be a chance for the European Central Bank to rethink its bond-buying program. The institution is facing a possible loss after acquiring the South African retailer’s debt as part of its so-called quantitative easing. The ECB could reduce the chances of a repeat.

The 800 million euro ($946 million) bond issued by a Steinhoff entity in Europe is an eyesore for the central bank. It bought the security in July as part of the QE program, which is intended to drive down borrowing costs for eurozone companies. Five months later, the bond has fallen to around 50 percent of face value after Steinhoff appointed auditors to investigate accounting irregularities.

However embarrassing, any hit will be very modest. The ECB doesn’t disclose how much it owns, but bankers reckon it buys bonds roughly in proportion to their share in the pool of eligible securities, which includes nearly 800 billion euros of investment-grade paper. Its portfolio is worth some 130 billion euros, so that would imply it holds around 130 million euros of Steinhoff debt. Even a total loss would be covered roughly 10 times over by the annual yield on the bank’s portfolio, assuming an average yield of 1 percent. The noise does, however, highlight the dangers when a public body like a central bank dabbles in allocating credit to companies. Valuing distressed debt and working through bankruptcies require specific expertise. And any loss can become a political football, providing fodder for critics of bond-buying. Ideally, perhaps, the ECB wouldn’t buy corporate debt at all. Yet eurozone rules limit the amount of sovereign debt it can scoop up.

Even the best investment-grade borrowers can hit hard times. But there’s at least one way the ECB could limit its exposure. Current rules allow it to buy any bond so long as one rating agency deems it investment grade, as with Steinhoff. Many investors prefer to have two ratings, because a single rating firm may miss a key detail or have softer rules. Citigroup estimates there are 28 billion euros of bonds in the overall collateral pool rated BBB-minus, the lowest investment-grade category, with only one rating. Excluding those, for a start, would still leave over 750 billion euros of securities for the ECB to choose from.