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After Vienna

03 October 2014
Richard Kemmish

I have to disagree with my friends at Global Capital. The jist of their conference summary was that covered bond people are incurable optimists. Like a declining industrial nation, we look to overseas colonial expansion to shore up a failing domestic economy. 

The inclusion of the words “..and covered bonds” to the ECB’s securitisation purchase programme  was to placate the Germans with their atavistic failure to embrace the new, improved, nothing could possibly go wrong this time, securitisation market.


It is true covered bonds outstanding have shrunk for the first time ever (oh the schadenfreude!). This is a small net change caused by two short term factors offsetting otherwise healthy expansion. The shrinkage of public sector pfandfbrief as a result of the 2003 abolition of gewahrtragerehaftung (you’ve got to love the German language) has run its course.

Likewise the shrinkage in retained bonds-for-repo is a case of ‘job done’.  The contrast with the calamitous decline in the securitisation market, both cause and quantum, is too obvious to be worth commenting on.

That outstandings in most developed markets have been broadly constant year-on-year - rather than the traditional 12% growth rate - is a sign of how good things are. As any DCM officer will ruefully tell you the combination of central bank liquidity, bank shrinkage and spread compression means issuers don’t need covered bonds right now. When normal or adverse conditions return, as they will, so will that long term growth trend.

What is interesting about the growth of the new markets is that it is in the face of more or less the same conditions. None of the Singaporean banks I spoke to in Vienna need funding, they too have abundant liquidity (and it isn’t central bank dependent there). But still they are working hard to join the market. Why? A big clue comes from the fact that they already buy covered bonds, they just want to sell them too. 

There was a lot of focus in Vienna on banks needing more covered bonds for LCR. Less focus on the  other reasons emerging why the system badly needs high quality, liquid, non-governmental liquid assets. From collateralising ISDAs to securing TLTRO advances the increase in demand for eligible collateral in the new financial architecture is on an eye-watering scale.

Whilst the scale of demand for these assets is sometimes overlooked, there is something more important, more overlooked: almost all of these new uses of collateral are subject to daily margining. Securitisation 2.0 seems to have spent a lot of effort trying to solve a problem that didn’t really exist in version 1.0: credit. But it overlooks the real cause of the problem – price volatility caused by the nature of the investor base (and correlation between their de-leveraging triggers).
To meet the needs of the system going forward, we really need a stable, large, real money investor base. There were plenty of them in Vienna and I, for one, think their optimism was justified.

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