Several years ago a French corporate with a large portfolio of public sector receivables asked, not unreasonably, if they could launch a covered bond? Their assets all conformed to the eligibility rules laid down in the capital requirements regulation, they were happy to structure the bonds in the same way that covered bonds were structured, they just werent a bank. So why not?
The simple answer was that one of the core principles in the definition of covered bonds contained in the UCITS directive was that they can only be issued by financial institutions. But why is there such a rule and is it still valid?
The best reason to limit the covered bond market to banks (anyone mind if I refer to credit institutions generically as banks? Apologies to any non-bank, deposit takers out there with a taste for pedantry) is that they have capital and more explicit regulatory supervision than non-banks. Both of which suggest that they will be less likely to fail than non-banks, the latter also means that the bonds they issue are more closely regulated.
I think we can safely discount the former argument on the basis of all of the banks that failed during the financial crisis (anyone remember a non-bank financial corporation that failed, apart from insurers?). The main value that regulation brings, other than a lower probability of issuer default, is that the bonds are certified as conforming to the covered bond rules. But there is absolutely no reason that I can see why a non-bank mortgage lender shouldnt have their mortgage and covered bond operations supervised in the same way.
Banks are more likely to be bailed-out than non-bank financials. But that can hardly be a basis for their exclusive access to the covered bond market, particularly now that tax-payer funded bail-out is so unfashionable.
The other main argument that I can see is that banks have alternative sources of funding to repay maturing covered bonds. Deposits and emergency repo funding at the central bank are useful alternatives to covered bonds. But not all covered bond issuers have them. And they are not sufficient as the existence of liquidity rules, soft bullets, etc proves.
The very fact that non-bank financials dont have access to these alternative sources of funding suggests that they have more potential financial benefit from issuing covered bonds. So far these non-banks have, in the absence of deposit funding, relied heavily on securitisations.
As so many recent regulations (the treatment of covered bonds in the NSFR, risk capital floors) make mortgage lending more difficult for banks, the share of non-bank financials in the mortgage market should grow. But as the securitisation market remains in the doldrums their need for better funding tools is growing. This is already the case in many emerging markets that are looking to introduce covered bond laws, in particular in SE Asia. The pressure is only going to grow in Europe.
Time to reconsider this tenet of our market?
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