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Would you recognise a covered bond if you saw one?

21 September 2016
Richard Kemmish

“And in Other news, the British have recognised the Island state of Singapore”. “How do you recognise an Island? You look a lot like Hawaii. Didn’t I see you at the Finemann bar-mitzvah last year?”

I was reminded of this quote when I heard a panellist at the Euromoney/ECBC Covered Bond Congress this year say that it was inevitable that Basle would recognise the covered bond market. This is good news, obviously, it’s nearly two decades since the possibility was first suggested but it has been of increasing importance in the post-crisis period.

It has two advantages, one practical problem and, if that practical problem isn’t overcome, one huge disadvantage. Let’s start with the good bits.
Within the European Union it has the potential to stop covered bonds being an ‘exception’. So far everything covered bond related in European law, from UCITS to our treatment under liquidity cover rules, has been a modification to what is supposed to be a standard, global set of regulations from Basle. The fact that there are many other modifications in many jurisdictions, not just the European Union, is scant consolation and does nothing to detract from the human tendency to want to reduce exceptions. It is a lot easier to argue to a cynical, anti-bank MEP that a pro-covered bond rule should be passed into European law if that rule is an application of one that comes from Basle rule rather than one resulting from industry lobbying Commission.

The second big advantage is outside the European Union. The new jurisdictions outside the EU have generally put in place half of the rule book – the sell side, not the buy side. There are lots of rules about what a covered bond should be, but domestic investors in the new jurisdictions could be forgiven for asking ‘so what?’. No preferential risk weights, no LCR eligibility, no enhanced repo treatment, etc.  It is more difficult to abrogate a Basle rule in favour of covered bonds than it is to insert one into a Basle framework that ignores it. 

But the practical problem is the one from my initial quotation (Good Morning Vietnam, yes of course you knew that). How do you recognise a covered bond? The potential for a wrong answer to that question is the drawback.

We know that the current definitions of covered bonds are almost entirely overlapping – there are some which are UCITS compliant but not Capital Directive compliant, but not many. The sole exception to this is the EEA-only rule which will presumably fall away if Basle recognises the product. 

Could there ever be a Basle definition of covered bonds independent of EU legislation? It would be a convenient way to avoid the arguments that have prevented European legislative definitions from being fully aligned. But it would provide yet another circle on an already crowded venn diagram.

We all want Basle to recognise covered bonds. But will it recognise the same covered bonds that we do?

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