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Floating pounds

26 January 2015
Richard Kemmish

Sterling floating rate notes certainly seem to be the surprise hot topic in the new issue market so far in 2015. But for me the real surprise was, why has this taken so long?

The sterling covered bond market has of course been open for a few years now but, relative to every other sterling bond market and relative to the number of British covered bond issuers its always been disappointingly small.

Why is this? I’ve noticed in the past that investors in any given country don’t tend to get excited about covered bonds until issuers from that country have been issuing them for some time already. Two to three years seems to be typical. I’ve noticed, but never really understood that effect.

But the Brits have been enthusiastic issuers of covered bonds for nearly twelve years – they are now the sixth largest source of euro covered bonds. So why haven’t the British asset managers got more enthusiastic about the product before now? I think there are two reasons.

To some extent they have been held back by their regulators. Whereas the EU’s preferential treatment for covered bonds has been enthusiastically followed by most national buy-side regulators, the British have been more reticent. Famously a deputy governor of the Bank of England said that it was not their business to express a preference for one asset class over another (even I, as a Brit and a libertarian struggle with that). 

Which leads to the second reason, the vast sterling securitisation market. Securitisations have always been cheaper than equivalent covered bonds, frequently considerably so, and the British are the most supportive of the product’s credit track record (don’t worry, I’m not going to reopen that argument here).

Now that the EU rules are more supportive of covered bonds and more directly applicable to the British (all of the important bits nowadays are regulations, not directives. Important distinction that) and that the securitisation market is shrinking, attitudes amongst British investors have to change.

Then there is the other side of the recent trades: that they are floating rate. The lack of development of a floating rate covered bond market is something I have struggled with for some years, not just because fixed rates are so laughably low at the moment (as I write a pfandbrief has just printed with a 10 basis point coupon).

Floating rate covered bonds are much better for issuers – particularly given the deteriorating credit rating of most potential swap counterparties (and hence cost of swaps).

They are also much better for the two classes of investors who are coming to dominate new issue bools. Bank treasurers loading up their liquidity books would prefer floaters (as that’s the basis that most of them run these portfolios on). Central banks (and for that matter other counterparties who take covered bonds as collateral) tend to haircut floating rate covered bonds far less than they do fixed rate.

Ironic that it takes the product agnostic, unenthusiastic Brits to lead the way on the rate basis.

Bring on the Euro floaters!

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