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Reasons to be Cheerful

20 February 2017

Two of the most reliable facts in the covered bond market are that new jurisdictions always take longer than you think to come online and that I am always an optimist. The latter is the stronger of these two forces so I’ll suggest that the rate of development of new jurisdictions should start to accelerate over the next few years. There are several factors underpinning my optimism:

Firstly, a lot of banks, particularly those who went into new countries, particularly when those new countries used to be much worse rated than their own, are now having second thoughts. As a result of both bank regulation (scarce capital, resolution planning) and poorer credit in the parent’s home market, the regulators in the daughter markets are increasingly demanding that their banks look after their own capital and funding. Whether this means that the parent bank exits the market or just leaves the local treasury to do their own thing, either way it means greater pressure for local funding tools.

Secondly, the EBA. For personal reasons I can’t comment on whether their December recommendations are going to make it into EU law or not, but I can say that they have published the closest the market has to the definitive guide: ‘How to structure your covered bond market’. I can personally vouch for how useful their 2014 publication was when helping countries put in place a new covered bond law; this is better.

Then there is the improvement in the cost effectiveness of the covered bond product thanks to the EU’s latest proposals on the Nest Stable Funding Ratio. It’s a topic that warrants an entire column to itself (I promise), for now suffice to say that the possibility of interdependence rules for covered bonds in this ratio takes away one of the few remaining reasons not to prefer covered bonds over senior unsecured funding. Yes, this is just in the European Union. But where the EU leads in covered bond regulation, other regulators may follow.

On which topic, Basle. Non-EU covered bonds so far have been almost entirely about non Europeans structuring bonds for European consumption despite the EU prudential treatment being for ‘EEA only’ covered bonds. Shove the words ‘covered bonds’ into the BIS rule book and not only do you open up non-EU investor markets for the product, you also increase the probability of a level playing field for non-EU bonds in the oldest and largest market.

Every article I read about the future of Fannie and Freddie in the US makes me think that the world’s largest housing market needs the world’s best housing finance tool.

Finally, most depressingly for us Europeans, the risk/return profile in the existing markets keeps deteriorating, making investing in the new markets increasingly compelling. As one of my panellists once said at a Euromoney conference, emerging markets are the countries where at least you get paid for the sovereign risk that you are taking.
I look forward to discussing this further at the upcoming Euromoney Asian Covered Bond Forum in Singapore next month.

For more information about the Forum, please visit the event webpage.

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