This report has been produced by the European Systemic Risk Board (ESRB) through a special expert group composed of members of its advisory committees (the Advisory Technical Committee and the Advisory Scientific Committee). The exposures that banks and insurance corporations have held vis-à-vis sovereigns have been seen by many as a source of fragility in the recent and prolonged episodes of financial stress, while others have seen them as a factor of crisis mitigation. The current regulatory framework of sovereign exposures held by financial institutions needs to be re-examined at a global level. The report describes the regulatory treatment of sovereign exposures in the European Union, analyses the incentives that it may create, provides data measuring those exposures and offers analytical explanations of recent developments. The report argues that, from a macro-prudential point of view, the current regulatory framework may have led to excessive investment by financial institutions in government debt. The report recognises the difficulty in reforming the existing framework without generating potential instability in sovereign debt markets, as well as the intrinsic difficulty of redesigning regulations so as to produce the right incentives for financial institutions. It examines a set of possible options which may be considered either on their own merits or in combination with each other, both in banking and insurance, offering a detailed discussion of the pros and cons. The ESRB is hereby providing the broader public in Europe and authorities across the world with a systematic analysis of macro-prudential vulnerabilities related to the sovereign exposures of banks and insurance companies, as well as illustrating how to pre-empt or mitigate them.