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One Year On (2)

12 August 2016
Richard Kemmish

Anti-bank sentiment may be the main threat to the impeccable track record of covered bonds (see previous post) but it wasn’t the only one discussed this time last year in Barcelona.

The other two threats identified were different effects of the same cause – that track record itself. In other words, could covered bonds be a victim of their own success? Two sides to this.

The covered bond idea has travelled well because of its track record. As ever more countries, increasingly with lower credit ratings and greater funding needs, look at the success of the product they seek to emulate it. Does this introduce new risks?

I have heard the argument before, when British covered bonds were introduced in 2003 they were governed by contract, not statue law, did not have a supervisory regime dedicated to the protection of covered bond holders. And, perhaps worst of all, were from a country with a tradition of securitisations. The supervisory regime was put in pace, the technology was seen to be impeccable (dare to say it: better than that in many more established regimes) and the myth of the inferiority of the product was disabused.

Will the same happen in emerging markets?

I declare a bias. I am hugely supportive of the introduction of covered bonds into emerging countries. Even so I see a lot of very relevant technology being introduced (transfer and convertibility risks in swap documentation for example), I see a far greater systemic importance for the product (Turkey needs covered bonds more than, for example, the Netherlands do) and, we have to be honest, sovereign risks in some non-EM covered bond markets. As a speaker at Euromoney’s Global Borrowers Conference put it: ‘the difference between developed and emerging markets is that in the latter at least you get paid for the country risk’.   

The other way in which covered bonds could be a victim of their own success is via the highly controversial expansion of the concept into non-traditional asset classes.

Since the last conference the hopes of the securitisation market for a workable EU regulatory framework for their product have been dashed. The gulf between the views of Commission and Parliament on the topic has been shown by the vast differences in their draft securitisation directives. It doesn’t help that the strongest advocates of a functioning securitisation market have just voted to leave the Union.   I do not see any prospects for securitisations to finance infrastructure assets, loans to small and medium sized enterprises or any other aspects of the real economy in any meaningful amount, any time soon. 

As an inevitable consequence, expect further pressure to either expand the scope of covered bonds into new asset classes or (preferably) to create a parallel covered bond-like market.

New asset classes, new countries, new risks? Is that necessarily a bad thing if the traditional covered bond market can sufficiently insulate itself from the newer markets?

Make sure to sign up the Euromoney/ECBC Covered Bond Congress 2016 to discuss this and more, by clicking here.

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