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The label's tipping point

17 December 2015
Richard Kemmish

On the covered bond panel at Euromoney’s CMU conference recently we discussed the take up of the ECBC’s covered bond label initiative. Currently it is about 75%. At this level, as one of the panellists explained, the onus is increasingly shifting to those who do not have a label to justify themselves.   The higher the take-up rate goes, the more pressure and the higher probability that this becomes a significant differentiating factor in pricing.

As is well documented, the vast majority of the 25% are issuers in either Germany or Austria. Their arguments are clear enough: the label is a brand that guarantees certain minimum standards, we already have one of those, enshrined in the law. What is ‘Pfandbrief’ if not our own, exclusive covered bond label?

Do investors accept this argument? Its impossible to tell currently. German covered bonds are of course the most expensive in Europe but this is a function both of fundamentals (they are good) and technical factors (lots of people have to buy them).

We all speak a lot about the most obvious technical factor – the ECB purchase programme. Although this should apply equally to all covered bonds they actually buy on average less of each pfandbrief new issue than they do in other jurisdictions. Whether this is due to the ECB’s national capital key not matching the countries that new covered bonds come from, whether it is due to the ECB taking a view on relative value or if it is a conscious policy decision, it is difficult to say.

Most intriguing of all though is the possibility that it might be due to the covered bond label. The ECB, like every other investor, must monitor and manage the risks in their assets. When you buy so many covered bonds, so quickly the existence of the label, in particular the standardised data aspects of it must be very helpful to your risk management department.

The technical factor that we speak about less is more specific to pfandbrief and has nearly run its course – the shrinkage of the pfandbrief market. According to a couple of supply forecasts I’ve seen recently next year will be the first since 2002 when the pfandbrief market actually has positive net issuance. With many pfandbrief investors being relatively passive – when a pfandbrief matures just reinvest the proceeds in the closest equivalent bond – it is clear that the market shrinkage has been a key driver of the spread performance that we have seen.
It isn’t just German issuers who are ambivalent about the label, it’s the investors too. If the pfandbrief market really does start growing again it must either attract non-German investors into the asset class or persuade German investors who have got sign-off for non-German (and hence labelled) covered bonds to come back to more expensive domestic bonds.

Either way the label is going to be of increasing importance to marketing. Not having the label will be increasingly difficult to justify.

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