Poll participants
HH, Fitch In February this year, the UK’s Financial Services Authority announced that it was working on a framework to allow UK banks investing in covered bonds meeting the Ucits directive to benefit from preferential regulatory capital treatment. Is this a significant development?
LH, vdp Yes it is, because it makes the product much more attractive to UK issuers and they are potentially very large users of this kind of instrument; it also reduces the risk weighting of covered bonds from other countries.
JO, Euromoney But do you think that English covered bonds, without primary legislation, will be naturally inferior to covered bonds issued through a specific legal framework?
LH, vdp It’s the market that decides. But I am in favour of specific legal frameworks because they give investors an unambiguous and transparent product.
LD, ECB I totally agree with Louis. A legal framework gives additional security to investors.
CV, Commerzbank The UK system is clumsier, because you have to analyse every issue in nitty-gritty detail. The more issuers that come in, the more difficult that gets.
JO, Euromoney I gather that after the February announcement residential mortgage-backed securities (RMBS) tightened and that now there is an expectation that some investors will treat asset-backed securities and covered bonds as equals and hold them in the same portfolios.
PT, SBAB I wasn’t expecting this convergence between RMBS and covered bonds to occur for a few years yet but I’ve always thought that they would eventually. There isn’t much difference between them apart from the legislation, and investors clearly don’t put a huge value either on having legislation or a huge cost on the analysis burden that various structures around Europe bring with them. The FSA announcement is perhaps the ultimate sign of convergence and this trend will continue.
JO, Euromoney That’s from the investor perspective. But do/will issuers regard the two products as one?
CV, Commerzbank When I was still in the structured finance team, we agreed with the covered bond guys that these products are complementary not competitive, because there are different reasons for issuing a covered bond and a securitization. You need both instruments for the best funding mix.
PT, SBAB Yes. At SBAB in the past we securitized for two main reasons – funding diversification and capital relief. Capital relief might not still apply after the introduction of Basle II, and reduces many issuers’ incentive to continue securitizing. But the funding diversification aspect continues to apply.
LH, vdp I agree with Claudia and Per it still makes a big difference whether the issuer securitizes or whether he uses the covered bond model. As for the tools to manage your risk in the cover pools, sometimes they are the same tools that you use in the structured finance world. No matter where these risk management tools come from, if they are good , why not use them. In so far I don’t see any difference between a covered bond and a structured covered bond, because all of the traditional covered bond issuers actively manage their pools and they use structured finance tools, because they all have to cope with the same kind of risk.
New markets
HH, Fitch Aside from the UK, there have been developments in a number of markets. Portugal’s legislation has just been passed, and they are looking at either having issues directly from the issuer’s balance sheet, or creating specialized subsidiaries with bank status. Luxembourg and Denmark are thinking about opening up the possibility for non-specialized institutions to issue covered bonds. What are your views on the best way forward?
LH, vdp For a country starting out in the covered bond market it might be easier to have a specialist, because it’s easier to segregate the covered assets from the rest of the bank. We know in Germany how difficult it is to have cover pools within the issuer, and if that’s not a specialized bank it makes it even more difficult. You have to think very carefully about how to segregate these cover assets in case of issuer insolvency. It’s also easier for an investor to understand if the issuer is a specialized institution.
PT, SBAB I think issuers with previous experience at securitization might find it easier to segregate the assets within the financial institution. Others without that experience should go the specialist-bank route. We have chosen to set up a dedicated subsidiary, even though we have previous experience. One reason is that this lets us clearly communicate one credit as being the covered bond credit and the other as being the unsecured credit. Another reason is to resolve swap problems and manage the interest-rate risk between the parent and the subsidiary. There are other benefits, and if you look around Sweden you will notice that all the potential covered bond issuers are already subsidiaries within banks, so they will become sort of specialist banks in themselves.
LI, Sampo The Finnish experience is very similar. It doesn’t involve any more work to have a specialist bank, except that you have to apply for the license. But the disadvantage is that there’s no recourse to parent company assets, but in our case that doesn’t really have any effect on the success of the bond.
JO, Euromoney There’s a possibility that Washington Mutual will issue the first ever US covered bond. But will covered bonds ever become truly popular with US issuers and investors?
LA, SGCIB There are others looking too, but the development of this market will depend on the Federal Reserve and the Securities and Exchange Commission (SEC). Australia is similar and there the APRA [the Australian Prudential Regulation Authority] looked at the idea and said no. As for investor interest, that will be a function of the development of a domestic market. Once investors become familiar with a domestic product then they look at other covered bond products. In that sense the US situation is comparable with, for example, Italy. Italy has a very large investor base that could be a powerful force in covered bonds but they don’t have their own domestic market and so are not very active investors yet. Obviously US investors also prefer dollar products and that is an issue. There’s also the point that in the US individual depositors are insured up to $100,000 by the Federal Deposit Insurance Corporation, so subordinating depositors is not the issue that it is in Australia, for example. The US could avoid some of the problems that other countries have faced.
