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The harmonisation debate: please vote

12 September 2017
Richard Kemmish

In my previous post I mentioned the new on-line polling that Euromoney Conferences will be using at the Congress in Barcelona. Whilst the previous panel that I discussed the questions for was on emerging market covered bonds, a subject close to my heart, the other panel that I’d particularly like your thoughts on is the discussion about the covered bond directive.

Also close to my heart, even more so because I am actually moderating that panel.

Again there are two questions that I’d like your thoughts on:

Is the proposed Covered Bond Directive, unnecessary? And if so is it – like the Earth in the Hitch-hikers Guide to the Galaxy – mostly harmless, or does it create some risks? If it is potentially useful is that because it brings weaker jurisdictions up to the standards of the best? Or is it going to be a benefit for everyone?

The oft-repeated mantra of ‘if it ain’t broke don’t fix it’ suggests that many in the market don’t feel that there is any need for a directive. Certainly the performance of the covered bond market and its ability to regulate itself – as demonstrated for example by the success of the covered bond label – suggest that the argument for change is less than compelling.

But are changes mostly harmless? Principles based rules are difficult to object to and, other than a few rearrangements of supervisory processes and auditors, unlikely to cause significant cost or market disruption. The difference between the first two options in the question for me boils down to whether the EBA’s proposals have gone beyond ‘principles based’ and too deep into areas that are technical and best addressed at a national level. And whether this causes significant, real problems.

Alternatively, there are plenty of reasons why a directive is needed. Past performance of the market is not necessarily a guide to the future – there are plenty of reasons why things might get worse for the covered bond market and therefore an upgrade is needed. Perhaps no covered bond has ever defaulted, but has any really been tested yet? Or has state aid or favourable resolution outcomes always come to the rescue? Would a covered bond work?

If you do think a directive is necessary, is it necessary only for the weaker covered bond jurisdictions to bring them up to the quality of the best? Or is no covered bond regime perfect – remember that only the Dutch ticked every box in the EBA’s analysis of conformity with the best practice principles.

The second question asks which of the proposals is the most problematic. Although the EBA make a huge number of proposals, having discussed them with a lot of stakeholders I can confirm that the Pareto principle certainly applies to arguments about covered bond regulations. Broadly speaking the 20% of the proposals that generate the 80% of the debate, and the problems with them are the following:

One level of over-collateralisation for all covered bonds. A minimum o/c of 5% sounds good but is it a false comfort – 5% is too much for some, too little for others. And is the idea of a standardised minimum even meaningful given the different ways in which it can be calculated?

Compulsory six month liquidity buffers, again sound like a good idea. But they are very expensive in some countries – to the point that they may put the economics of the product into question – and they were designed for one particular model and might not offer the right level of protection in others.

Should extension triggers rely on an issuer defaulting? Europe is divided down the middle on this point. No-default triggers could provide liquidity for an issuer in extremis and thus contribute to the stability of the financial system. But only potentially at the expense of the covered bond itself.

Finally, as discussed in the first question, we could be opening the party up to non-EEA covered bonds. Is this sensible from an investor perspective? Does it disadvantage European issuers?

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