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09 June 2014
Richard Kemmish

“apart from the sanitation, medicine, education, wine, public order, irrigation, roads, fresh water system and public health....what have the Romans ever done for us? “ – The Life of Brian

Much the same could be said of the Italian covered bond market. The OBC law, similar to the regular covered bond law but for loans to SMEs – is a sensible compromise between the need to fund this vital sector of the economy (particularly in Italy where SMEs are so important and mortgages still a comparatively small part of the economy) and the risk of diluting the Italian covered bond brand, or for that matter the covered bond brand in general. But it is only the latest in a surprisingly long chain of innovations that have come from Italy.

The Bank of Italy’s perspective on the encumbrance debate is still unique. When the covered bond law was originally passed they set a limit on covered bond issuance. But, unlike other regulators since, they did not specify one size that would fit all. Rather they linked the limit to the issuer’s capital ratio, reasoning that what really matters to unsecured creditors (who might be subordinated behind covered bond claims) is whether there was sufficient capital to protect them from the default in the first place. Why has no other regulator gone down this eminently sensible route?

Then there is the innovation that covered bonds should be able to price through the government curve. Maybe it was an inevitable consequence of the trend towards public sector covered bonds pricing wide of mortgage bonds (and maybe it is obvious that the average Italian homeowner is more trustworthy than the average Italian politician) but it took cojones to actually price a bond 100bps through the government curve (Unicredit, Chapeau!)

Another first for Italy was the widespread use of parallel programmes with unrated covered bonds which exist only for repo at the ECB. They would of course argue that the value added from covered bonds is the regulatory and legal regime – which is the same if you are rated or not – and that ratings are unreliable anyway. But the reality is that if you aren’t being given credit for excess overcollateralization by the ECB then why waist it on them? Better to save it for the public programme. This same logic has also been applied to the use of commercial mortgage pools in separate programmes (the market would discriminate, the ECB doesn’t) and the use of conditional pass through structures (ditto).

For a relative new comer to the covered bond market (ignoring the special case of CDP it was really only 2008 that issuance got started), Italy has certainly been punching above its weight in terms of innovation. But then again, they always have done. 

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