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Where do covered bonds come from? The Covered Bond Blog

27 February 2015
Richard Kemmish


I’ve often said that covered bond is a brand – like Champagne - not a technique – like making sparkling wine. The phrase ‘Covered bond’ was originally an attempt – I believe in the mid-90s by a journalist - to group together broadly similar bonds in different countries, pfandbrief, obligations fonciere, etc. The unifying factor was not an economic similarity – the bonds were much more different from one another then than they are today – but a paragraph in the UCITS directive.

Already though it was an arbitrary distinction (in fairness to the journalist in question he never attempted to define the parameters of the market – just group articles on broadly similar bonds in a section of a magazine).

For example, there were those entities that issue in their own name secured on loans secured on the underlying assets – CRH in France for example. They could very easily have argued that they were agencies rather than covered bonds – as agencies at the time tended to trade tighter than covered bonds it would have been in their interests to do so. But (fortunately for us) they claimed membership of the covered bond community.

Then there are bonds not issued by ‘credit institutions’. I know that there is an official EU legal definition of credit institution but it is no more than convention. Does the intermediation of a fund between the issuing credit institution and the bond itself negate the fact that the credit institution is the issuer? No, by convention. What about a credit institution that neither takes deposits nor has access to central bank repo operations? Again no, again arguable.  

But the most arbitrary distinction – again this is convention - is geography. Because we, as a market, formed our assumptions about what a covered bond is long before we exported the concept outside Europe and because there is a common layman’s understanding of the concept it didn’t occur to anyone that we had to define Europe.

For practical purposes there are three competing definitions of Europe: the European Union, the European economic area or the geographical construct – the laymen’s definition. By default we chose the latter so Switzerland (non-EEA) and Turkey (straddling the continental border, therefore the rugby convention applies: ‘on the line’ is ‘over the line’) were included. But if the founding definition of our market really is one paragraph in UCITS (which only applies in the EU/EEA) then is the geographical construct the appropriate definition? 

Academic point until we became a global market. Just as no-one felt an urge to define champagne until other countries started making sparkling wine.

Several non-European (in the geographical definition) housing agencies are very similar to for example CRH or the Swiss Pfandbriefbanks. The Federal Home loans Boards? The Korean Housing Finance Corporation? Are they covered bond issuers?  I’m not saying that every non-European mortgage agency should be considered a covered bond issuer, that would be absurd. But in these two cases for example there is a case to be made.

Just as a Nyetimber sparkling wine consistently outscores an equivalent price champagne.

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