What Should Asian Covered Bonds Look Like? Part II
10 Feb 2017
In my previous post I discussed the extent to which Asian
covered bonds should attempt to mimic their European brothers.
It is of course ridiculous to generalise a market as diverse as
Asia, covered bonds from Singapore can, should and do replicate
European (and in future Basle) structures, covered bond from
other countries in the region cannot and should not.
But what are the main areas of difference in the structural
details to consider?
Firstly, not every national banking system is rammed full of
the residential mortgages that are the mainstay of the asset
class in Europe. Although there has been plenty of talk of
alternative asset classes in a European context the impetus for
this has weakened recently. This is, I think, a function of the
liquidity in the European banking system banks are no
longer running out of traditional assets to put into their
covered bond programmes to fuel their central bank repos.
But the European debate provides some pointers about which
asset classes may be acceptable. Generally it is agreed that
the alternative assets need to be granular, credit worthy and
homogenous. Occasionally people also require that the assets
themselves should have a low risk weighting, should have
security over a physical asset and should be of importance to
Secondly, how many assets do we need for any given bond? In
Europe there is often a cap of 15% on other assets
in the pool, in Belgium they have the more sensible approach of
reversing that and requiring that there are at least 85% of the
primary assets in the pool. This is straightforward and prudent
when you fund the assets in the currency that they are
originated in or in a currency that is tolerably well
correlated to it. This does not work very well when you have a
volatile foreign exchange rate against the euro. If the
exchange rate halves, my bond backed by 100 residential
mortgages will suddenly be backed by 50 of residential
mortgages and 50 of derivative exposure. Not allowed in Europe;
should be elsewhere.
Then there is the matter of local insolvency rules. European
covered bonds are increasingly structured and rated with
reference to the bank recovery and resolution directive. Take
this away and you need a better covered bond framework
to take into account the lack of uplift due to bail-in
exemption for covered bonds and more emphasis on, for
example, the transfer of servicing if you assume that a bank
operational failure is concomitant with senior bond default.
Perhaps the question needs to be reversed. It is not what are
the main areas of difference, but the main areas of similarity
that we should focus on. My preferred answer to that is simply
to refer to the European Banking Authoritys Best
Practice Recommendations for covered bonds. I would argue
that conformity with those guidelines is both necessary and,
given the above comments, sufficient for Asian covered bonds to
gain true acceptance for European investors.
I looking forward to discussing this further with you at the
upcoming Euromoney/ECBC Asian Covered Bond Forum in Singapore.
The Forum will take place on Tuesday 7th March 2017. For more
click here to visit the event webpage.
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