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Gruner Pfandbrief

20 July 2016
Richard Kemmish

Apologies for the German title. ‘Gruner’ you know (yes you do, if only from the political party). Pfandbrief is the German (trademark protected) word for a covered bond – a full recourse secured bank bond. It’s a venerable instrument with rules as strict as the Reinhetsgebot and almost as old. It also – like the Reinhetsgebot - works very, very well. Famously no pfandbrief has ever defaulted.

The Gruner Pfandbrief, an award winning idea pioneered by Berlin Hypothekenbank, was essentially the application of the use of proceeds model to the traditional pfandbrief structure. The underlying assets were energy efficiency mortgages.  Its success (and my comments in the two previous posts) got me thinking about how to take the idea to the next level.

The Gruner Pfandbrief must conform to the Pfandbrief law’s list of eligible assets, largely mortgages. It also must be issued by a credit institution, in this case a bank, but not for example a special investment fund. It also must be backed by all of the mortgages of the issuer – green and other. Berlin Hyp managed to achieve pricing pretty much identical to their normal pricing because the bonds were exactly the same credit quality as a regular pfandbrief.

Covered bonds in general (that is throughout Europe) must be backed by specific assets (defined in article 129 of the capital requirements regulations if you really want to know) and must be issued by a regulated credit institution – these are EU wide, not just German rules.  If they tick both of these boxes (and a few others, the details aren’t important for current purposes) a huge swathe of benefits are available– preferential treatment for insurance investors, bank investors, UCITS funds, eligibility for the ECB’s purchase programme, exemption from bank resolution directive rules, I could go on. These benefits are nothing to do with a moral judgement on the rights and wrongs of funding residential mortgages or of keeping this business in the banking sector, they are a pragmatic response to the fact that the bonds that tick the boxes are both highly credit-worthy and highly liquid.

Incidentally, a major problem facing the covered bond market currently is that there are too many buyers and too few bonds.

As part of Capital Markets Union the European Commission may be publishing a Covered Bonds Directive in the near future.  The details, including which assets are eligible and who can issue are still up for discussion.
The covered bond market is fiercely protective of it’s definitions, they have served it well. I would never dare to suggest any fundamental changes to them.  But it also has a lot of structuring technology that has proven itself in even the most stressed scenarios. With the right lobbying of Commission a ‘parallel’ green covered bond market could be developed. With the same financial technology and with access to the same investor benefits granted by Commission, it would have the potential to unlock a vast frustrated investor base for climate beneficial projects.

We'll be looking at this in more detail at The Euromoney / ECBC Covered Bond Congress on 15 September in Dusseldorf.

Berlin Hypothekenbank will also be speaking at The Euromoney / GlobalCapital Sustainable and Responsible Capital Markets Forum on 6 September in Amsterdam.

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