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3rd Wave

20 May 2016
Richard Kemmish



In his opening remarks at the CEE covered bond conference John Baskott described what is happening in central Europe as the third wave in the development of the covered bond market. To recap, the first wave was in western Europe as many countries came on line in the period from 2003 to 2007, the second wave was when non-European countries (Australia, Canada, New Zeland) joined the party after the financial crisis.

To say that things like this happen in waves, rather than just at random through time as the country gets around to passing a new covered bond law, suggests that external factors must be the driving behaviour. Certainly that was the case for the first two waves – HBOS, by structuring a bond under contract law without a statute law in place, showed that this could be done and, that if authorities don’t pass a covered bond pdq they will lose control of the process.

The second wave of issuance was largely a result of the crisis. Regulators and banks saw that covered bonds had thrived in the extreme stress scenario in Europe and that they could be a force for systemic stability – not just another toy for a bank treasurer. The fact that these countries all had high credit ratings, common law jurisdictions and traditions of securitisations (therefore both a gap to fill and an IT platform up to the task) probably explains why they all came to the covered bond market in such quick succession.    
But what is the external driver of the third wave? Why now?

There has never been a shortage of covered bond laws in central and eastern Europe. What there has been is a shortage of good covered bond laws. Currently there are six countries in the region that have covered bond laws but no covered bonds. The third wave is a combination of upgrades of old laws, new laws and existing laws actually being used for public issues for the first time (as in Turkey).

The drivers are economic, not legal.

Firstly, it is about demand as much as it is about supply. Thanks to the ECB there is no spread, no yield in the traditional markets. The interest shown by investors in everything that happens in the CEE region – whether it be the recent Euromoney conference or the work that I do with the EBRD is testament to the frustrated demand for covered bonds with actual yield.

Then there is the equalisation of credit quality. Many central and eastern European banks are now far better rated than many traditional covered bond issuers further west. The idea that CEE is one big emerging market – with the risk and distinct investor base that implies - is increasingly indefensible. 

But even more important is the tendency away from intra-group funding in the region. For economic considerations in the parent group or policy considerations such as Vienna 2, CEE banks increasingly have to self-fund. Fortunately we have the tool to help them do that.

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