Financial regulators are unloved, often with good reason. So it’s only fair to praise them when they do a good job.
The new guidance on UK covered bonds from Paul Sharma’s prudential standards department at the Financial Services Authority follows discussions with issuers and underwriters that those involved describe as exemplary. Issuers like the FSA’s flexible stance on when covered bond issuance becomes material. And the FSA chose to communicate its views on a product that is known for its transparency in as clear a way as possible.
Outlining the contents of a letter to an industry body, in this case the British Bankers’ Association, at an on-the-record press briefing, is not standard practice. But the FSA has learned its lesson. Last August, many market participants mistook its written suggestion to the BBA that covered bond issuance should be monitored once it reached 4% of total assets as a suggestion that the regulator was setting a limit.
This time, FSA has got its message to the market directly, denying analysts the opportunity to misinterpret its words. As one banker puts it: “Nobody can accuse the FSA of hiding, or of getting spun.”
That’s doubly important because the FSA’s audience is not limited to UK covered bond issuers. It’s no secret that financial regulators talk to each other. Dutch authorities are already looking closely at the FSA’s reasoning in anticipation of their own covered bond market growing. So is the European Covered Bond Council.
The FSA was never against covered bond issuance. Indeed, it is a proponent of the benefits, and Sharma stresses that the covered bond market is a significant extra tool for banks to manage liquidity risk.
And the established continental covered bond markets will also scrutinize the FSA’s views. First, its positive view of the product will help UK issuers compete with those from Germany, Spain and France.
“Getting over the reservations about structural subordination puts us on a fair footing with our European cousins,” says a senior treasury official at one UK covered bond issuer.
Having got over that hurdle, the FSA can now look at other areas where the UK feels discriminated against, such as risk weighting, or Ucits eligibility.
In the much longer term, the FSA could even influence the shape of the Pfandbrief market. At the end of 2004, Deutsche Pfandbriefbank had total assets of €190 billion. It had issued about €50 billion-worth of public sector Pfandbriefe – well over 20% of assets. At Deka Bank, the proportion was closer to one-third. Because big German issuers are not always deposit takers, their issuance relative to assets is rarely capped. In theory, that could change.
Since Germany abandoned the specialist bank principle last year, universal banks have had the option of issuing Pfandbriefe. If BaFin ever decided to look at limiting issuance, it could well draw on the FSA’s work. Helmut Bauer, who runs banking supervision at BaFin, worked at the FSA for two years, for Sharma. The FSA might have taken an important first step in the long process of bringing the UK and continental covered bond markets into line.
