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Next flight to Rio

07 November 2014
Richard Kemmish

The life of a covered bond banker within DCM is not an exciting one. The charms of Stockholm and Vienna do tend to wear a bit thin when you have to visit them six times a year. So news of an imminent Brazilian covered bond law has cheered a lot of weary hearts.

But before they pack their pitch books and speedos, bankers might want to wait out to find out what the law is for, because the details in the public domain so far aren’t clear. Quite simply, is this for domestic or international consumption? Either way it is going to be a very different market from the other new kid on the block, Singapore.
When structuring a new covered bond law there are some key decisions that need to be made based on the target market for the bonds. Swap limits, as Turkey found out the hard way, should not follow the European 15% limit if you want to sell bonds in euro backed by assets in lira. Moroccan government bonds should not be eligible substitute collateral unless you are planning to sell the bonds to Moroccan investors. Issuance regulations ideal for big banks issuing jumbos in euros are potential deal killer for small regional banks targeting local investors in their own currency. I could go on.
But why would an emerging market prefer the covered bond market to be domestic anyway? In emerged markets such as Singapore the covered bonds are clearly developed for reasons other than funding (they’ve got loads already). Potentially this could also be the case in some emerging markets.
The mobilisation of existing capital within the countries is often held back by an underdeveloped capital market. Lots of emerging markets have big domestic pension funds. Can you persuade them away from their default setting of owning practically the entire equity and govvie bond markets until there is a credible, liquid fixed income market?

Which is not to say that Emerging Markets don’t need foreign capital – obviously they do. But the development of a domestic market in covered bonds mobilises existing capital within the country. Just as importantly it provides a robust refinancing market that will help the ratings of the bonds when they do go off-shore (nothing like a domestic investor base to fall back on when the rest of the world goes wrong). Also, it serves as comfort for new investors. You only have to look at the credibility that the first Swedish euro denominated covered bonds get from the existence of a vast, successful domestic market.

The answer of course is to find a set of regulations (not laws, you need to be flexible) that facilitate domestic issuance first but allows for upgrade compatibility when the time is right to issue offshore.  Not as easy as it sounds. But something that the DCM bankers might want to ponder on the long flight down to Rio. And they might want to lower their expectations of imminent jumbo issuance too.

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