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A change of focus

13 November 2014
Richard Kemmish

In the City of Girona in North East Spain is a small deserted apartment block occupied by squatters. It is quite possibly the most dangerous building in the history of the covered bond market.

Let’s face it, we’ve done pretty well out of the first phase of the regulatory response to the financial crisis; covered bonds are part of the solution, not part of the problem. Phase one of the response to the crisis was about financial stability, growth (and just a bit of banker bashing).

But it’s clear from the results of the last European parliamentary elections, and the rise of populist ‘politicians’  from Beppo Grillo to Russell ‘Reloveution’ Brand that there is a broad mandate for a different approach. In regulatory terms apparently - thanks to Wolfgang Kalberer of the VDP for making this point - this may take the form of a shift of focus towards ameliorating the impact of the financial crisis on ordinary citizens of the EU.

From a humanitarian point of view this is understandable, it may be trite to say that the human cost has been terrible, but that does not make it any less true. But from our point of view, is it going to impact the credit worthiness of covered bonds? Put simply, does it bring into question fairly fundamental assumptions about the sanctity of property rights? Probably. Does it question the fundamental forecloseability of mortgages? Possibly.
Which is where the squat in Girona comes in. In a key test case before the European Court of Human Rights, the right of the owners of the apartment block to evict the squatters and sell the property were deemed to be subordinate to the rights of the squatters to have housing (under article 3 of the European Council Convention on Human Rights).  The court, in a landmark ruling said that the squatters could stay put until their right to housing was guaranteed by the state in the form of social housing.
We have already seen some instances of governments setting aside contracts included in cover pools, usually as a result of behaviour of the bank which with hindsight was irresponsible – I’m thinking of for example the recalibration of foreign currency denominated mortgages (usually Swiss francs) at an off market rate. This was ok, the covered bonds effected did not default or even get downgraded as a result (as far as I am aware), largely because of the dynamic nature of cover pools and the fact that the banks that missold the mortgages were still solvent. It would be a fascinating test case of securitisation contracts if these mortgages had been included in cover pools in their markets. Would the investors be able to demand compensation from the bank?

But there are now two key differences between the Swiss franc mortgages and the Girona ruling. Firstly the new resolution rules, we can no longer assume that the bank will be solvent when the problems in the cover pool are identified. What if the pool had already been segregated? Secondly, there is no hint of miss-selling here. In Girona the bank in question had done nothing wrong, they were incidental victims of a change in social attitude as a result of the crisis.  

Perhaps covered bond investors might also be incidental victims?

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