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Covered bonds and CMU

17 November 2015
Richard Kemmish

The debate about what capital markets union can do for the covered bond market has been more or less totally eclipsed by the subsequent consultation specific to covered bonds. Commission’s consultation is the practical application of the high ideals of CMU to our particular corner of the markets. 

But there is still the parallel discussion about what the covered bond market can do for CMU. Obviously, as an advocate of covered bonds I am going to say that they provide a fantastic precedent for much of what CMU is trying to achieve – I’ve already commented, many times, on the cross-border nature of the covered bond market, which puts most other fixed income products to shame. But I would also add the fact that reform has been industry led, which is in line with Lord Hill’s desire to work with industry rather than to impose from above.

Further, the covered bond market has set its own parameters very successfully via the ‘common features definition’ and then by the evolving definitions in the covered bond label. The label is not unique - the CP market STEPs initiative is similar in terms of its definition of minimum standards - but it is unique in the extent to which it has helped to define a potentially amorphous asset class. It is even leading the discussion about the future definition of the product by dropping the ‘EEA only’ qualification for inclusion. Commission, please note.
There is one big area though where Capital Markets Union needs to make progress where covered bonds have failed: liquidity. I doubt if any other fixed income market has tried as many initiatives as covered bonds to ameliorate the impact of regulation on secondary market liquidity. That they haven’t succeeded can only partially be blamed on the ECB’s purchase programme.  I don’t think I’m going out on a limb when I say that the development of capital markets as an alternative to banking is going to be severely limited as long as there is insufficient price transparency – for the retail investors – and insufficient secondary liquidity- for the institutional investors.

But if CMU is ultimately about rebalancing the relative roles of bank and capital market funding (rebalancing meaning: making more like America), then what are covered bonds? They are funded in the capital markets but remain on bank balance sheets – unlike securitisations which replace the banking system with securities.

It touches on the very core identity of the covered bond product that its greatest support traditionally comes from the countries where attitudes towards CMU have been seem to be most ambivalent – usually because the banking system is seen to be ‘fit for purpose’ by end users and there is a cultural distrust of untrammelled securities markets.
Is this (dare I say it?) the first time since the crisis that securitisations have been more in tune with the Brussels zeitgeist than covered bonds? As the agenda shifts from stability to growth it might not be the last time.
You have been warned.

We'll be discussing this and more on the covered bonds panel of the forthcoming Euromoney Capital Markets Union Forum in Brussels on 3 December.

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