Has Brussles got the market covered? | Jumbo liquidity hit by a big freeze | Investors force the pace
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Buschmann: the new law
enables German issuers to
remain competitive |
A HUNDRED AND five years after the German Mortgage Bank Act was passed and 10 years after the jumbo Pfandbrief was born, the German covered bond market, rightly seen as the pioneer of the European sector, has just undergone two substantial changes: the new Pfandbrief Act; and a change of law relating to the funding register.
The new Pfandbrief Act, which took effect on July 19, was necessitated by two factors. The first was the consolidation of the banking market in Germany, which was blurring distinctions between different types of banks. Despite consolidation, the Pfandbrief market was notable for historical anomalies that gave issuance privileges to specified types of banks, thus reducing competition.
The second and more important factor was the removal of state guarantees for public sector Landesbanken as a result of an edict from the European Commission on unfair competition. Without their state guarantees, Landesbanken would not easily have been able to access highly rated and cost-effective funding. Therefore, a new regime for covered bond funding was required.
The government took advantage of the need to deal with these constraints to shake up the Pfandbrief market. The Pfandbrief Act consolidates the laws relating to public sector, mortgage-backed and shipping Pfandbriefe. In addition, mortgage banks are no longer specifically defined in law. Now, any bank can issue Pfandbriefe provided it procures a licence and meets requirements, such as continuing issuance to ensure liquidity, set by bank regulator BaFin.
Triumph of simplicity
“On the face of it the change looks small but it is really huge,” says Hélène Heberlein, head of European covered bonds at Fitch Ratings in London. “The achievement of the legislation can perhaps be best seen when it is compared with the situation in Austria. There changes have been brought in but three or four legal regimes have been maintained. What has happened in Germany is a triumph of simplicity.”
The Act also includes new features that should enhance the already high regard that investors have for Pfandbriefe. Chief among these are tighter regulatory requirements for issuers and tougher disclosure and transparency rules. Specifically, issuers now have to reveal more information on the quality of cover assets and other risk parameters on a quarterly basis, compared with the previous annual reports.
“The transparency improvements in paragraph 28 of the Act cannot be overstated,” says Heberlein. “Previously, issuers were reluctant to publish any information and investors always wanted to know more.” The new Act also requires disclosure of such figures as the net present value of the cover pools and the results of stress tests defined by BaFin, as well as the maturity structure of outstanding cover assets and Pfandbriefe.
Ralf Buschmann, head of origination in the financial institutions group of debt capital markets at Deutsche Bank, says that the Act will help the Pfandbrief market maintain its leading position in the European covered bond market – a clearly beneficial side-effect from the viewpoint of the framers of the law. “It allows the German market to compete with other jurisdictions that to some extent have been seen as more flexible,” he says.
The Act is an advance for the entire European covered bond market as well as for the Pfandbrief market. As Hans Diehl, head of funding at Eurohypo, notes, the Pfandbrief Act is a strong law “that could be the basis for other European laws in the future. It would not surprise me if we see it used as the benchmark of new legislation across Europe in five years’ time.” He adds: “In the meantime, [the Act] certainly positions the Pfandbriefe better to compete with the other new centres of covered bond issuance in Europe such as Spain, France and Ireland.”
The implications of the Pfandbrief Act are still uncertain. The mortgage banks have taken advantage of their new ability under the legislation to expand their business into non-German activities. “In the past there were country limits but now there are no restrictions within the EU and a 10% ceiling for all non-European business,” says Buschmann. “It gives banks more flexibility.” Commercial and residential mortgage loans from the US, Canada and Japan can now be included in cover pools.
Similarly, some banks have taken advantage of the legislation – specifically the end of the specialist bank principle – to merge their mortgage banks with parent banks. Heberlein says: “Why have two issuing entities in the same bank group when you can now have one? Rationalization is certainly a consequence of the Act.” Consequently, the Act could change the shape of the banking sector in Germany.
However, the effect of the Act has been limited to date – largely because decision-making at large organizations is slow; the big commercial banks are currently considering whether to apply for a Pfandbrief licence. As Eurohypo’s Diehl notes, this is a tough decision: the credit risk management requirements for Pfandbrief issuance are harsh and only a small group of banks are likely to be able to fulfil them.
Moving assets
Just as significant in terms of its impact on the Pfandbrief market – though less explicit in its intentions – is the change to the law on the funding register. This took the form of an amendment to the German Banking Act, which was passed in July and came into effect on September 28. The amendment changes the law relating to the funding register – or refinancing register, depending on the translation – and has important implications for both Pfandbrief issuance and securitization in Germany.