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What Should Asian Covered Bonds Look Like?

07 February 2017

...European covered bonds? The approach taken by Asian covered bond issuers to date, most obviously in Singapore, has been to make Asian covered bonds look as much as possible like European covered bonds. It is obvious enough why. If you make the covered bonds similar to the existing product you make it easy for the existing investor to buy it. Yes, you still need to get sign off for a new country with all of the due diligence that implies, no, you don’t get a preferential risk weighting but at least the structure is familiar. That’s one less thing to worry about in the credit memo.

This approach makes perfect sense particularly in the current environment – a dearth of traditional bonds from traditional countries and a negative yield on most of the ones that are out there.

It also makes perfect sense given the regulatory trends. There are two aspects to this. Whatever the outcome of the current process we know that the direction of travel preferred by the EBA and the European Commission is towards a greater degree of standardisation (harmonisation, call it what you will) within the European regulated covered bond market. The possibility of new asset classes is perhaps at odds with this but any new asset class is primarily judged against the extent that it looks like the existing asset classes and can be forced into their framework.

Then there is the possibility (probability?) of Basle recognising the asset class on a global basis for the first time. Is European harmonisation going to make that more likely? Quite possibly. It will also most likely form the template for the idea of covered bonds in the Basle framework. The benefits that accrue from Basle recognition of the asset class are only likely to come to those that conform to this model.

But there are two challenges to this orthodoxy: can’t and shouldn’t.
In Singapore this doesn’t apply but in many Asian jurisdictions you just can’t replicate the European model. Singapore has a strong credit rating, a prudent supervisory framework, clarity of legal process and lots of home loans. Drop any one of those four conditions and it suddenly becomes impossible to make something that looks like a pfandbrief. Drop the conditions too much and it becomes impossible to meet even the harmonised minimums that are the European covered bond ideal.

Take Turkey for example, there aren’t enough traditional assets and the sovereign rating is not so strong. By necessity, the authorities there designed something that does not meet the European definition.

And the example of Turkey leads to the ‘shouldn’t try to replicate the European model’. The fact that the covered bonds there are often backed by loans to SMEs and have different structural features has in no way held back investor appetite for the product. On the contrary.

But what about the details? The structural features that must change to make Asian covered bonds work? Let’s discuss that in the next post.

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