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Interesting covered bonds

09 December 2015
Richard Kemmish

Is Singapore four times more interesting than Turkey? With all due respect to both countries, no.  But it is according to an investor survey published recently by Societe Generale where they asked ‘which new covered bond regime is the most interesting to you?’ Interesting in this context probably refers to an attractive risk/return profile and anticipated supply rather than the traditional use of the word. Or perhaps investors just find the Byzantine empire a bit dull.

Can I suggest a compromise definition of interesting? Interesting could refer not to the country’s history or to the economics of the new covered bonds but to the structure of the covered bonds to come next year. Singapore, for all of the right reasons, has quite an uninteresting covered bond law. They closely mirror best practice in established markets and produce covered bonds that are highly comparable as a result.

On the other hand, Turkey, and for that matter all of the other countries in central and Eastern Europe are more interesting.

For example, countries that have less well developed FX swap markets must find new ways to issue in euros. So far in western Europe only the British fund most of their covered bonds in a currency that is different from that of the assets.  Similarly, the 15% limit on swap exposures in covered bond pools is fine when asset and liabilities are either in the same currency or in currencies that aren’t particularly volatile but a major headache everywhere else.

Then there are liquidity mitigation rules. In fixed rate Europe where plenty of high quality substitute assets are available, asset side solutions are straightforward. In Poland, for example, clever (and interesting) liability side liquidity mitigation tools have had to be developed.
In Turkey loans to small and medium sized enterprises are both a more pressing need and a more suitable source of assets. The implications of which could take up an entire conference in themselves.
Many covered bond investor country buy-lists are limited to the EU/EEA/G10/AAA countries/places colonised by the Brits. Whereas that doesn’t sound particularly exclusive it does imply that some CEE covered bond issuers have to expand that eligible country list and/or start selling the idea of covered bonds to emerging markets focussed investors. Neither task is trivial. 

But the most significant and potentially interesting (in the investor sense of the word) feature is the credit rating of the countries. CEE sovereign credit ratings are of course massively diverse, so are those of western European states in the Euro. But at least in the latter case the currency zone ameliorates many of the effects of the sovereign rating.  A higher yield for CEE covered bonds is one of the inevitable consequences.

Covered bonds from CEE are less than 1% of those from Western Europe. The vast majority of countries so far have no functioning covered bond law but many are working on it.

New structures, higher yields, more supply. How can anyone say that isn’t interesting? 

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