I know that I have touched on this topic before but now that the certainty of a Brexit from the European Union is sinking in I think it is worth highlighting one particular, important and almost totally ignored implication: it is great news for covered bonds from outside the EEA and emerging markets in particular.
Quite simply the idea of a mutual recognition of covered bonds from other jurisdictions that is, the EU recognising non-EEA covered bonds and the country in question putting in place preferential treatment for their investors to buy EEA covered bonds is an excellent idea in practice and a non-starter in reality, until now.
Obviously the more diverse your portfolio, the better the risk diversification in terms of both credit and liquidity risks. When you are holding covered bonds to protect you from domestic risks for example, in case of a failure in liquidity in the domestic banking system you hold a large portfolio of liquid covered bonds the benefits of diversification become far greater. Similar arguments apply for the benefits of investor diversification for the sell side, or would do if selling covered bonds wasnt so ridiculously easy thanks to the ECB.
Why has it been a non-starter in practice? Firstly, non-EEA countries just havent bought in on the idea of preferential treatment for covered bonds in investor portfolios. If they dont grant preferential treatment for their domestic covered bonds they certainly arent about to for foreign ones.
This is about to change. British investors hold a lot of EU issued covered bonds in both sterling and euros, largely on the back of their current (EU defined) investment rules. I suspect that the Solvency Directive and Capital Requirements Directive will be high on the list of technical pieces of European legislation for which even the most ardent Brexiter will accept a straight cut and paste into English law.
Secondly, no-one has ever defined what an equivalent regime would look like (see my earlier discussions on this topic). But as the UK regime is already clearly adequate for EU purposes it will be difficult to argue that it wont be post-Brexit (unless the British decide to materially change it on exit, which seems unlikely).
I make no political comments, there are enough of those already. But it seems fairly obvious that this is one of those cases where both Britain and the EU are incentivised to put in place a structure that keeps the current rules intact. By doing so they create a precedent for every other covered bond jurisdiction outside the EU with a high quality supervisory regime. Countries such as Canada and Australia will only be able to benefit when they put in place investor protection.
New countries outside the EEA that have yet to introduce covered bond laws however can (should) easily put in place equivalent buy-side rules and supervisory regimes and reap the benefits of mutual recognition.
To hear more about this topic, make sure to register for the Euromoney UK Conference this September.
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