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Best Principles

16 June 2014
Richard Kemmish


Another aspect of the EBA’s recent covered bond project (see previous blog) is that they have attempted to define ‘best practice’ in covered bonds on behalf of the ESRB. The phrase ‘on a hiding to nothing’ springs to mind.

Covered bonds in different countries are very different. They need different things, even down to - to pick just one example - LTV limits which need to take into account how values are determined and how volatile property prices are. Therefore anything that you say about best practice in one market isn’t likely to be particularly useful in another.

The EBA have obviously realised this and seem to have adopted an approach of using subtle wordings for their recommendations which are not predicated on any one country’s covered bond model. Inevitably the subtlety will be lost in translation. It’s beyond me how any meaningful convergence is going to come from the requirement that property values are ‘updated or revalued and monitored’. Sounds like, ‘carry on with what you are doing’, to me.

Then there are those jurisdictions who are enthusiastic followers of fashion in the covered bond market (for example, those with mainly floating rate mortgage markets who nevertheless adopted ALM and liquidity matching rules because the Germans did). I can see eager regulators transposing the EBA’s recommendation that cover pools contain compulsory liquidity buffers into national laws. Which would be a bit pointless in those jurisdictions where most programmes have already developed alternative liquidity mitigation tools, such as extendible maturities and conditional pass throughs.

There is also the risk that the lack of precision will make the recommendations less useful than they could otherwise be. Which begs the question, what are the best principles actually for? The ESRB seems to think that it is of “..paramount importance that covered bond frameworks converge towards common practices of safety and robustness”. Despite the presence of euro buzzwords ‘safety’, converge’ and ‘robust’, I’m not sure that I can agree with this. Common destinations, yes. Common routes, no.

The one size fits all approach to covered bond regulation has already had a lot of casualties – the statute books of Central Europe are littered with covered bond laws that don’t work.

But the Principles of Best practice now exist (or at least will be formally published in the next few weeks) and will be referred to by well-meaning commissioners, regulators and law makers. As guidelines they have the potential to be useful, as hard rules, potentially destructive. Let’s hope that the end users of these principles can tell the difference.

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