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Mutual recognition of equivalent regimes. (1) Mutual?

26 May 2016
Richard Kemmish

The European Commission consultation on covered bonds hinted at the possibility that the ‘EEA only’ bit in EU regulations might be up for negotiation. Should it? Yes, obviously. The detail might be the tricky bit.

If Commission is to allow investors to invest in non-EEA covered bonds and treat them in the same way that they treat the home grown equivalents, they need to answer two questions – are the covered bonds as good (hopelessly ambiguous word, I’ll come back to it)? And do the arrangements need to be reciprocal?

The Federal Reserve famously grants preferential treatment to pfandbrief ‘but not covered bonds’. When I questioned this anomaly I was told that it was clearly not ideal but that solving it “isn’t exactly on page 1 of our to do list”. 

Whilst it isn’t a priority for the Fed it might be for the regulators in Canada, Australia and Singapore – for example. Singaporean banks being allowed to invest their liquidity portfolios in high quality liquidity assets that aren’t issued by Singaporean entities is clearly a great diversification from the sort of crisis that makes them hold these portfolios in the first place.

But will they put in place rules to allow this without a reciprocal treatment from the European Commission for their bonds? Yes, if they are driven purely by a desire to increase the stability of the Singaporean financial system, no if they are influenced by their own bank’s plans to get the best possible pricing for their bonds in Europe.

The relationship is not symmetrical. Singaporean issuers need European investors far more than European issuers need Singaporean investors. That is only marginally less the case when you look at the larger of the non-EEA markets, Canada and Australia. Still much smaller than Europe in terms of bonds outstanding, but even smaller again in the more important measure – the size of the covered bond investor base.

Which suggests that the impetus for change must come from the new markets. But this is a problem. The most difficult thing is to persuade a regulator that preferential treatment should be granted for an asset class. Defining the exact borders of that asset class is then less controversial. The European Commission will find it easier to expand preferential treatment to non-EEA issuers than regulators in non-EEA countries will to grant (any) covered bond preferential treatment in the first place.

But if non-EEA regulators make this leap of faith and start to recognise all covered bonds - no matter where they are from – in investor prudential guidelines it will be difficult for Commission to not grant reciprocity.

Now is a great time to do this. It is far easier to expand the universe of eligible bonds when we are fretting about a shortage of bonds than when we have a glut.

There will of course be quality hurdles for eligible investments to clear to win this recognition. But I’ll have to postpone that to the next post.

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