The European equity markets have stabilized lately as the region’s politicians finally address the Continent’s sovereign debt crisis. But while policymakers have made some progress toward a solution, they have yet to achieve a consensus approach.

Christian Noyer, the governor of Banque de France, recently said that the European Central Bank wouldn’t expand its bond-buying program. After a difficult period of politicking, Slovakia’s parliament eventually rallied enough votes to expand the role of the European Financial Stability Facility. And Germany’s messy internal politics have kept Chancellor Angela Merkel walking a tightrope between divergent interests as she tries to resolve the crisis without sacrificing precious political capital.

As it stands, the only point of agreement among European powers is that Greece will ultimately default on its sovereign debt. Policymakers are now discussing how to manage the consequences of such a default on the Continent’s banking system. As part of that process, another round of bank stress tests may be in the offing.

While regulators did conduct a round of stress tests on the largest institutions in the region earlier this year, they did little to force the banks to raise capital and shore up their balance sheets. But the situation has rapidly devolved since then and cracks are beginning to appear in the European banking system, most notably in banks’ short-term capital markets.

So in early October, the European Banking Authority said it planned to launch a new round of stress tests on European banks. Given the massive rout of European banking shares over the past several months, there’s little doubt that a new round of stress tests will demonstrate the need for a forced recapitalization of the banks. According to data from the Bank of International Settlements, German banks hold $40 billion worth of exposure to Greek debt, while French banks hold an estimated $65 billion of Greek debt. Although Greece’s fiscal profligacy is well known to market watchers, other nations, such as Spain, Portugal and Italy, could also default on their debt.

If the stress tests are performed with the assumption of a true worst-case scenario, their results should demonstrate a clear need for a recapitalization of the banking system. That should give authorities the will to compel troubled banks to actually raise sufficient capital this time around.

While the broad market will likely be relieved to have the crisis abate, bank investors should expect their stakes to take a hit. The most optimistic scenario involves a recapitalization in which banks are able to raise additional capital themselves at the expense of further dilution to existing shareholders. Should banks be unable to raise such capital on their own, policymakers could implement a program of recapitalization that would likely be modeled after the Troubled Asset Relief Program in the US, which stabilized banks, but imposed onerous restrictions on them.

The prospect of an eventual resolution to the sovereign debt crisis makes it tempting to initiate a position in Europe using broad regional ETFs. However, the outsize role the financial sector plays in the European economy means that it’s heavily represented in exchange-traded funds’ (ETF) portfolios. Vanguard MSCI Europe ETF (NYSE: VGK), for example, currently has an almost 20 percent allocation toward the sector. Though beaten-down financial sector shares offer attractive yields, a regional European ETF with substantial exposure to this sector is still too risky at this juncture.

For now, focus instead on buying the country- and sector-specific ETFs most likely to benefit from the ultimate resolution of this crisis.

What’s New

Market Vectors Renminbi Bond ETF (NYSE: CHLC) was the only new ETF launched last week. It’s now the third fund to launch in recent weeks that focuses on so-called “dim sum” bonds, renminbi-denominated debt that’s issued in Hong Kong.

While the fund’s benchmark index tracks about 45 issues, Market Vectors Renminbi Bond ETF currently holds 16 positions, with a few names that might surprise some investors.

Western companies are taking advantage of the low prevailing interest rates in China to secure cheap financing. And Chinese savers are piling into their nation’s burgeoning bond market in their bid for income-producing securities. As a result, the ETF’s portfolio includes bonds issued by McDonalds Corp (NYSE: MCD), as well as the finance arms of Caterpillar (NYSE: CAT) and Volkswagen (OTC: VLKAY).

The fund’s average holding has a coupon of 2.2 percent and three years to maturity. Almost half of the fund’s holdings are rated higher than ‘A’ by Standard & Poors. While the balance of the portfolio’s holdings are not yet rated by S&P, they are rated investment grade by other rating agencies such as Moody’s Investors Service.

An investment in the fund is essentially a bet on the appreciation of the Chinese currency. While the Chinese don’t currently allow their currency to truly float freely, they have been taking steps in that direction. For example, they now allow offshore trading of their currency and have even let the renminbi appreciate slightly vis-à-vis the US dollar. And the fact that Chinese authorities are allowing dim sum bonds to be issued is yet another step toward loosening their control of the currency.

The fund’s expense ratio is 0.39 percent, undercutting its competitors in the dim sum bond space.

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