Venn diagrams: The Covered Bond Blog

25 Feb 2015 | Richard Kemmish


Whilst preparing for a training course I’m about to run on covered bonds I was trying to make a venn diagram of the competing definitions of the asset class. It’s trickier than it looks.

I gave up when  I reached the 9th subtly different definition (ok, if you insist: UCITS, Capital Requirements Directive for risk weight purposes, Capital Requirements for liquidity cover ratio, ECB eligible repo collateral, ECBC Label, Iboxx covered bond index, Solvency 2, Barclays covered bond index, GlobalCapital league table). None of these cover exactly the same set of bonds as each other.

Odd that we are thought of (even market ourselves as) an homogenous asset class. The securitisation market has long embraced its diversity and – dare I say it – initiatives such as the PCS in that market are an attempt to ape some of the standardised qualities of covered bonds.

Following on from my recent comments about capital market union and the ever present threat of a ‘Covered Bond Directive’, it begs the question whether it would be helpful if Brussels were to align at least those definitions that it is responsible for. If they were to do that, maybe the definitions coming from the market would fall into line?

Well no, probably not. I think that this would be one of those gratuitous, doing it for the sake of it, sort of standardisations. Most of those definitions are not competing with one another, they are being used for different purposes.

The definition in paragraph 129(7) of the capital directive is attempting to measure the credit risk of the asset, the definition in the technical standards supporting the liquidity cover ratio calculations is trying to measure the liquidity risk of the asset. Totally different, it would be absurd to try to unify them.

Why do people want to standardise definitions? There is a human tendency to try to keep things, particularly categories of things, neat and clearly defined. I don’t think it’s a very healthy psychological tendency so let’s focus on a possible alternative; the signal effect of a category.

Does it really matter if any given bond is UCITS compliant? Leave aside the debate over the wording of the definition and look at what it I used for – an exemption for a certain type of fund from an issuer concentration limit that no sensibly run fund will be anywhere near - and the answer is clearly no.

How about the risk weighting? Surely that’s important? Er, no. Lots of covered bonds are owned by banks, true. But how many are held on the banking book? And for most covered bonds the improvement in capital treatment is 10% of the face value of the bond (standardised approach) or difficult to generalise but broadly similar (advanced approach). Hardly material given the swings in the risk weights of, say, the mortgage assets that back the covered bonds.

And yet we do care, deeply about meeting the criteria. It can only be because of the signal effect that we want to be in the core of that Venn diagram.


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