The UK Treasury has delayed the implementation of the UK’s recognized covered bond law until March 6 from its originally planned date at the beginning of January. Although some have reasoned that this is because of last-minute objections raised by the UK Investment Management Association (IMA) concerning, among other things, insolvency procedures, the actual reason is far more administrative. "Industry worked closely with [the UK Treasury] and the FSA on the development of the proposed covered bonds regime," says Rob Robinson, covered bond analyst at Merrill Lynch. "However, many of the consultation responses were informed by market events over the summer, which raised new issues for consideration. It was made apparent to industry by the authorities upon receipt of these responses that the previous timetable would not be attainable. Fundamentally there is nothing wrong with the legislation or with the approach being taken towards its implementation."
If one of the larger banking institutions and a small-time outfit both commented or made requests for information, the FSA and the Treasury would have to give each an equal weighting. Although this is a fair and decent way to go about things, it does require a lot of time, especially considering the sheer volume of feedback received by the authorities, Robinson says.
This feedback is not necessarily negative, although many market participants were reportedly worried by how "hands-off" the approach of the framework appeared to be in light of the credit crunch. "After the summer we’ve had, the market understands that a more hands-on approach is needed, with stricter regulations concerning the cover pool," says Armin Peter, head of covered bond syndicate at UBS in London. "The market wants a balance between flexibility and being seen as having a strong and stringent framework."
The semantics of Peter’s remarks should not be overlooked. What is important is not the actual strength of the product itself, which isn’t questioned by those close to the legislative process but the strength that it is perceived to have. What affects spreads in the covered bond market more than anything else is the mindset of investors, which is why the comments of the IMA – relative outsiders in the process of implementing the regulated covered bonds law – could have a negative effect on UK covered bond spreads. "Anyone on the inside would know that we are trying to accurately represent the 10% risk weighting awarded to legislated covered bonds," says a banker involved in the UK covered bond legislative process. "Everyone who knows these regimes knows that they are products of the highest quality."
But the delay in implementing the law has proved timely. Had it been implemented now, the launch would have taken place under a dark shadow. Capital market disruption has again crippled the covered bond market. AIB’s decision to postpone its mortgage-backed deal even after the books had opened shocked the industry, and all market making has been suspended on the recommendation of the European Covered Bond Council’s "eight to eight" committee.
Although most participants believe that the market will return in the new year, the initial recovery is likely to be so tentative that the new implementation date for UK recognized covered bonds of March 6 might coincide nicely with a return of investor appetite in the covered bond markets.
Should that happen, the delay could have another benefit. The mindset of investors could be such that the delay will be seen as an attempt to further fortify the legislation, which could play well with investors and lead to tightening spreads. However, some say the delay in halving the risk weighting of UK covered bonds from 20% to 10% might have the adverse effect. But Robinson at Merrill disagrees. "In my opinion, [the delay] will have no effect on spreads," he says. "The existing UK covered bonds were launched with the mentality that there was no legislation, so nothing has changed."