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New issuers: please vote!

11 September 2017
Richard Kemmish

At the covered bond conference in Barcelona this year Euromoney Conferences will be asking for the audience’s input. For many of the sessions the moderator has selected a couple of key questions for the subject of the panel and is encouraging your input, either now or when you attend the panel.

One of the panels – panel 3 – looks at new issuers and ideas in the covered bond market. As the two questions for this panel are particular interests of mine I thought it would be worth elaborating on the questions.

Question 1 asks if covered bonds from emerging markets are most interesting for, regular covered bond investors looking for yield, regular emerging market investors looking for protection or local currency investors?

Data and anecdotes suggests that so far it’s been the traditional covered bond investors looking for yield. There are precious few covered bonds available in western Europe with any meaningful spread over mid-swaps and most of the ones available are in southern European countries where you are already at your country limit. Bonds from, for example Poland offer yield, diversification and strong credit in a market badly lacking at least two of those.
But there is also a strong argument that emerging markets – even well rated ones – behave in a way that traditional covered bond investors aren’t used to. An emerging market fund manager understands the countries, has credit lines to them and is used to and more able to cope with the political and flow volatility that is an inevitable consequence of being in an emerging market index. Covered bonds can be correlated to but potentially outperform EM indices in a downturn. Furthermore, the investors trusting fund managers with their money do so in the full expectation that they are exposed to the specific value drivers of emerging markets. Mainstream covered bond investors do not.

But if you want covered bonds to be a real force for good – rather than just funding a few mortgages at the margin – then it is the local currency investors who should buy them. In many countries these investors have nothing liquid to invest in between government bonds and equities. If my pension fund were denominated in Romanian Lei I’d be I’m desperate for some high quality alternatives in between those two extremes.

The second, related, question asks about whose covered bonds should be the beneficiaries of preferential prudential treatment under EU law.

Currently, as we know this is only available for issuers from the EEA. There is an argument that regulators not subject to European Union control – no matter how nice they are – should not be able to make a judgement on covered bond quality for EU investors. Furthermore, from a policy point of view, covered bonds should be about recycling investments within the Euro zone for the benefit of the Eurozone economy.

Alternatively this principle could continue to apply but with Britain added post-Brexit – for the dual reasons that this is the status quo (and changing that would be very disruptive) and that Brits are bigger investors than issuers so, from a purely selfish point of view, it is in the eurozone’s interest to keep this particular border open.
Investors may prefer to be able to apply prudential treatment to a wider universe of bonds with some quality control, which could be based on the country’s rating or, for example membership of the G20.

Most radically, prudential treatment should be available to any covered bond regime of sufficient quality – it’s up to the investor to make choices about which country to invest in, not Brussels.

All of the options are defensible. Please vote in the poll, available for all registered Congress attendees, in the conference app now and come to the panel in Barcelona to hear what your peers think.

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