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Covered Bond Blog: Who is your regulator?

20 July 2015
Richard Kemmish

Western Europe is divided in two in many different ways, core/periphery, Catholic/Protestant, Germanic/Romance language groups, conquered by Napoleon/saved by the Brits, wine/beer drinkers. One of the more politically incorrect (and therefore fun) games is to try to work out which of these dichotomies are best correlated and what the direction of causation is. The ‘core’ countries (almost) all drink beer, the peripheral all drink wine, one of the strongest correlations of the crisis (and certainly explains why Ireland has returned to the ‘core’ so rapidly) but it is difficult to argue a causation. Perhaps editors of The Sun and Das Bild could give it a go. 

But one divide through the heart of Europe doesn’t attract anywhere near as much attention and is even more difficult to explain: whether covered bonds are regulated by the central bank or a separate regulator – usually called the Financial Services Authority. According to my calculation (inclusion criteria: I could remember who the regulator was off the top of my head) divided covered bond regulation into 9 central banks and 11 ‘FSA’ type regulators.

Why can this possibly matter?

Simple: conflict of interests.

If the body responsible for regulating the covered bond market is also the body responsible for protecting monetary policy and in particular, providing emergency liquidity – as Keynes put it -  against high quality collateral to solvent institutions (ha!) – the potential for conflict is obvious. 

Now this potential conflict has been around for a long time and no-one has worried too much about it. But a couple of things have occurred recently to make it a bit less theoretical. The Greek crisis, obviously. The Bank of Greece is the lead regulator of covered bonds and, de facto, the largest investor in them (by a truly enormous margin). 

Then there is the introduction of a single bank supervisor for significant Eurozone banks (in the form of the ECB, was any thought given to an E-FSA I wonder?). This new supervisor introducing new intra-agency conflicts of interest with existing regulators and national central banks.

Please don’t think, by the way, that this potential for a conflict of interests means that I am siding with those countries where the ‘FSA’ rules the covered bond market. The FSA nations have just as much potential for a conflict of interest to the extent that they typically have responsibility for the regulation of investors. In particular the FSA is usually the body that decides whether covered bonds are good enough to allow investors such as pension funds and mutual funds to: a) invest in them at all and b) invest in them on a preferential basis relative to, say, bank unsecured bonds. 

The only way to avoid any conflict of interest at all would be to create more regulators and move away from the FSA/Bank dichotomy entirely. But that would put us into the realms of the US style multi-regulator. Which is even worse than a traditional European binary regulatory structure. And we wouldn’t want that now, would we?   

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