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Covered bond debate: Covered bonds continue to seduce

Despite a more uncertain rate and credit environment, new issuers and investors continue to enter the covered bond market. As the boundaries between traditional and structured products blur, Asia and the US are the targets.


JO, Euromoney  The covered bond market is one of the largest and fastest-growing sectors of the fixed-income markets. Let's review the current developments behind that success, then look at some of the remaining concerns and finish up by looking at what may happen in the future. Helene?

New issuers, new countries

HH, Fitch Ratings  Perhaps a good place to start is with country developments. Ziad, what do you think have been the most interesting from the investor perspective?

Awad, Goldman Sachs: issuers who
establish a poor pattern of secondary
market performance will find it
harder and harder to correct.

ZA, Goldman Sachs  The key development has been expansion outside Germany and in particular the rapid growth of the Spanish market. Spain is likely to be larger than Germany for the first time ever in terms of benchmark issuance. Also the UK covered bond market has come on line, starting with HBOS, over the last couple of years, and, very importantly, Ireland has seen rapid growth in issuance, thanks to a new and very sophisticated covered bond law. Finally the home market, Germany, has reacted positively and has launched a new Pfandbrief law, which is rejuvenating that market in something of a virtuous circle. JO, Euromoney  Yes, I was just in Spain and we have Ahorro Corporacion looking at issuing up to €70 billion a year and other Spanish issuers have focused on issuing in very large size.

HH, Fitch Ratings  This morning [May 4 2005] the Italian Senate has approved the legislation for the Italian covered bond. So that is another market that will provide growth in the asset class.

WHN, Depfa  So how many Italian issuers are lining up? 

JO, Euromoney At least half a dozen I know of.

New products

HH, Fitch Ratings Another driver has been the increase in what were initially thought to be competing products. Other types of structured bonds, far from taking investors from Pfandbriefe, have actually increased interest in the asset class as a whole.

WHN, Depfa Definitely.

LA, SG CIB  Over the past six to nine months I've seen increased interest out of Asia for these covered bond products. Part of that has been due to the new issuers. We're also seeing renewed interest out of Canada.

JO, Euromoney  Are investors confused by the change from a legal branded market into a credit market in which investors have to analyze each credit and each structure?

WHN, Depfa  I don't think they are confused. Certainly it means investors have to have the ability to analyze the pure credit, as well as the structure, of the product. And it is also a question of price.

DB, HBOS  Remember that even in Pfandbrief, investors have always had to look at the underlying credit story. When we came into the market, there had been a number of downgradings within the Pfandbrief market. People learnt that they had to look at the originator, at downgrade risk and so on. Also, in establishing our programme, we modelled it on the best practice in Pfandbrief and tried to create something that investors would be familiar with, rather than a structured credit product.

TB, Allianz  Absolutely – people have always had to analyze credits and structures because one triple-A is different to another. Six months ago, many market participants told us that there is a high de-linkage of covered bonds from their issuers. After the negative credit news in the recent past, we saw that even triple-A products widened one or two basis points and different issues behaved differently. So we do need to analyze the issuer and the structure even if it is a Pfandbrief-law backed issue.

ZA, Goldman Sachs  If you're talking about the public-sector-backed covered bonds, you are buying into European sovereign risk, and if you're buying a mortgage-backed covered bond, you're buying into the European mortgage market and a structure that makes it a triple-A. The differentiation at the moment is not huge between those different credits, because the structuring has become very sophisticated and the two products have been sold at the same time in a very similar way, but I think we have to be very careful when selling to investors and to be clear about what we're selling to them and educating them appropriately.

LA, SG CIB  I think issuers have made an effort. I also think the rating agencies need to look more carefully at what collateral is in the pool. I remember back in 2002/2003, when we saw some of the public sector issues at triple-A S&P and double-A3 Moody's. From a prop trading point of view we said, 'Triple-A S&P at 25 over swaps? Maybe we should buy some'. Then we went to management and they asked, 'Well what actually is in there?' and the issuer sent us a six-month old Excel pie chart of the collateral with lots of pretty colours but no real detail. That has all changed.

TB, Allianz  If we are talking about covered pools, one interesting thing is, as you know, in July in Germany the Anstaltslast & Gewährträgerhaftung [Landesbank state guarantees] will be removed. So loans affected by these regulations are no longer cover pool eligible. But in Luxembourg it will still be possible to put them in the cover pool. So investors must be very careful and must understand what's in the pool and the underlying law.

HH, Fitch Ratings  Is it harder for issuers to explain structured covered bonds than Pfandbriefe? David, do you have to explain the differences between you and your securitization master trust?

DB, HBOS  No. If you do that, you start to confuse the investor. All you want to say is, 'This is our story. You have a double-A bank and triple-A security'. We want investors to accept the credit story and focus on liquidity because in triple-A it's liquidity that should drive the price.

WHN, Depfa  So, when you roadshow a structured covered bond, do investors try to compare it with the legally-backed covered bonds? Do they raise questions with respect to that?

DB, HBOS  It's not really that much of an issue, because although some countries have specific legislation, in the UK we already have the common law that supports these types of transactions. This same law is used successfully in securitization with which investors are already comfortable.

WHN, Depfa  I agree to a certain extent, because introducing the Irish product uses underlying English common law, but on top has a specific legal framework.

DB, HBOS  That is different. The Irish needed the specific legislation. The UK doesn't.

ZA, Goldman Sachs  Coming back to the roadshow questions issue: one of the questions I remember the most was about the UK housing market and we get that on Spanish covered bond roadshows as well. That tells us that investors are really focused on the pool and the quality of what is in the pool not what law the bond is issued under.

CS, Caja Madrid  Exactly. Of our roadshow presentation, 70% explains the mortgage market in Spain; the remaining part of the presentation is on the credit quality of the issuer and on the Cédulas legislation.

LA, SG CIB  Since Spain is the market which is the least bankruptcy remote – yes it's triple-A and S&P has adjusted its ratings methodology – to what degree do Spanish issuers feel the need to lobby – like the Germans lobbied – to have the law modified or to alter their structure? Is there a concern on the Spanish side?

CS, Caja Madrid  There was concern at the time. There was criticism from the German Pfandbrief market that the Spanish Cédulas market didn't have a good enough insolvency law. It took Spanish issuers a long time and many roadshows to explain to the market the law as it stood at the time. At the beginning of last year we had a change in the Spanish insolvency law, which brought us up to the Pfandbrief standard, and this year we've had changes in the withholding tax legislation, which finally enables us to place our bonds to investors outside the European Union.

HH, Fitch Ratings  Carlos, one question specifically on Spain. I've talked to many people who do not differentiate between the Cédulas and the repackaging of Cédulas. What's your point of view on this?

CS, Caja Madrid  We raise our Cédulas funding using both formats. We issue through Caja Madrid and also through TDA. Basically, there is not much difference as far as investors are concerned. What investors want to hear is about the mortgage market. That's the underlying risk behind either the direct Cédulas or the structured Cédulas. The only differentiation we had in the past was the rating: the structured Cédulas had a triple-A rating from three agencies, the other had a triple-A rating from only one agency.

TB, Allianz  We like that kind of repackaged Cédulas – the AyTs and TDAs – because we are attracted by the higher degree of diversification they provide. And I think the technique should be used in Germany where there are a lot of savings banks that issue small amounts of covered bonds. We think it would be a very progressive development to see the same kind of repackaged savings bank issues in Germany.

HH, Fitch Ratings  Well, in the new Pfandbrief legislation, having Pfandbriefe as collateral of a Pfandbrief issue will no longer be allowed.

TB, Allianz  We are very comfortable with the new law, because we think to include Pfandbriefe in the cover pool would weaken the quality of the Pfandbrief. But, on the other hand, repackaging Pfandbriefe in a separate structure would be an advantage to the market, like it is in Spain.

Better liquidity

JO, Euromoney  Talking about positive developments in the market, what about liquidity? Has this improved?

WHN, Depfa  Liquidity is the biggest topic in this asset class. At Depfa, we have always believed that liquidity is key to our success. In bullish markets bigger is better and we finally came up with our e5 billion issues which are trading extremely well and are stable. But thinking about new issuance these days, first of all you have to check what the market can digest. In a bear market you have to pay a premium to get size done.

LA, SG CIB  But liquidity is not only about size, it's also about trading. Depfa no longer requires the market-making agreement and that doesn't seem to effect your pricing at all. For HBOS or the Spanish issuers it's still a factor. What sort of importance should we put on the market-making agreement?

Höfer-Neder, Depfa (centre): US investors
will buy dollar-denominated covered bonds.
It's just a question of time

LD, ECB  I think it's a crucial part of the market. Depfa is a special case but the whole market, especially the newcomers, needs it.  ZA, Goldman Sachs  But the wide use of electronic platforms now provides liquidity in a more standardized and homogeneous way and creates minimum standards.

JO, Euromoney  And we can't pretend that the covered bonds market is the government bond market can we?

ZA, Goldman Sachs  Well, we see it as a parallel to the US agency market. The covered bond market in Europe is bigger than the government bond market, but it offers a spread pick up, and at the same time it happens to offer a very high rating and high liquidity in the secondary market.

LA, SG CIB  And the liquidity commitment has held up under some fairly tough conditions. In 2003 when HVB bonds widened close to 30 basis points, the market proved itself and I think the commitment from market-makers is still there.

New maturities

TB, Allianz  Continuing with liquidity developments, the positive news for investors is that finally we have liquidity at the long end of the covered bond curve. Some of this has been driven by the weight of issuance by Spanish issuers, but the fact is that where there wasn't really liquidity over 10 years, now we have a curve up to 20 years. Of course at 10 years plus the curve is pretty flat – even inverted for some issuer types – and, looking at the roll down, the most attractive part of the curve is between five and seven years. But there is liquidity now at the long end and this is a good development. We were even asked a few weeks before if we were interested in buying 30- or 50-year covered bonds.

CS, Caja Madrid  We have looked at the possibility of doing up to 30 years and a few banks have already tried to do a 30-year transaction with us as issuers. The problem is that it would be very illiquid.

WHN, Depfa  The problem is that there won't be any trading in that kind of paper. The insurance companies are short duration and they would buy this paper and just hold it.

DB, HBOS  True but we're issuing for funding and if there is a nice deal out there at 30 years with a new investor base then that's attractive. We issued at 15 years at a better price than we could achieve in the 10-year due to the benefit of the sterling-euro basis swap, so the pricing made sense. But it's an investor-driven market and if there is demand issuers will tap it regardless of the liquidity issues.

CS, Caja Madrid  In the long run I think you might get some criticism for it. For instance, I remember when we did our first 15-year transaction four or five years ago and it traded well below our 10-year benchmark. Investors criticized us, saying that we should not have a 15-year transaction trading eight basis points through our 10-year which was trading at the right level. If we then tried to explain that that was an illiquid one-off deal and they should not take much notice of the price, some of them said, 'Well, I don't know if I like your bonds any longer because they go illiquid'. It can cause problems, in some cases.

 JO, Euromoney  So what else can issuers do to manage liquidity across the curve?

CS, Caja Madrid  Focus on benchmark issues. As a Cédulas issuer, we generally issue once or twice a year and we use benchmark public issues – no private placements – because we want liquidity for our issues. I agree that there's nothing worse than having an illiquid issue, especially when you promised investors a liquid benchmark issue.

LD, ECB  I think issuers have got to learn to listen to investors – and I think most now have learnt that lesson in this market. There are still retention deals around, but from an investor point of view, a pot deal is definitely preferable to retention.

LA, SG CIB  I think the market has really reformed. Yes, we had a recent retention deal and the spread widened by one or two basis points and subsequently tightened back in, but it wasn't like in the bad old days when loose paper stayed on primary books for months. I do think there is still a slight problem with those smaller, very price-sensitive issuers who come to the market and who can give the market a bad reputation for opportunistic issuance.

JO, Euromoney  I suppose they have different objectives. Wally has to pay to be a benchmark borrower but she gets access for that.

WHN, Depfa  Exactly. If you are a frequent issuer and you need access to liquidity in all market environments, you have to pay what investors ask. If you don't need that name recognition, if you don't want to build a liquid curve and you can get banks to raise money at very tight prices then that's fine.

ZA, Goldman Sachs  It's definitely the case though that issuance style has become much more professional and standardized. It's worth pointing out that this includes the banks in the middle who are behaving responsibly and giving the best possible advice.

DB, HBOS  Yes, and you need that good advice to ensure your pricing is right. But there are still issuers out there with the wrong strategy – one in particular has brought deals that were not well-executed from a market perspective.

LA, SG CIB  As a former market-maker who's been through Asia, LTCM and 2003, I would point out to the issuers that spread movements were rumour-driven, driven by market-makers and not investors. Now you spend a lot of time and effort on roadshows to convince investors. But there should be also an effort made to keep the market-makers informed too.

TB, Allianz  Issuer transparency is key in lots of areas. For example as an investor you need to be able to see what's in the cover pool. There are issuers who provide sufficient information about their pools – some on the internet – and there are some who do not.

DB, HBOS  Issuers generally try to price their paper correctly and if they do then it should perform in the secondary market. But if it doesn't and you sold it at what you believed honestly was the right price, I don't think the market should penalize you.

ZA, Goldman Sachs  I agree. But issuers who establish a poor pattern of secondary market performance will find it harder and harder to correct.

CS, Caja Madrid  I would try not to give mandates to banks that have lead those kinds of issues. I want my issues to perform and I want banks to make money out of my issues – but not if they use it to subsidize other issuers.

WHN, Depfa  You need to be careful about that! I came to the same conclusion three years ago, but you'll find you're on your own if you do that!

JO, Euromoney  What about the overall market's performance against its comparables?

LD, ECB  Covered bonds trade against swaps, not government bonds, and performance has been driven by very strong tightening, rather than the credit story of covered bonds. That means that when swap markets widen, then you have performance risk against the benchmark, even if you have a positive credit view on covered bonds.

ZA, Goldman Sachs  That's a good point, but in a widening swap spread environment we would expect covered bonds to improve against swaps. Currently they perform somewhere between swaps and governments which means they'll widen slightly to governments but they'll outperform swaps, and that will definitely be different from what's happening in credit, where credit is going to cheapen to swaps.

LD, ECB   I think there are also a lot of customers who buy covered bonds in an asset swap package and don't necessarily have to look at swap spreads.

ZA, Goldman Sachs  It depends on the portfolio. In a government bond portfolio, covered bond widening to governments is negative. In a covered bond portfolio the same move only hurts if you are overweight to the benchmark.

WHN, Depfa  I think looking at covered bonds against the swap market is more a European view. I think the Asians and Americans look at spreads to governments. They don't care about the swap market. One thing that I found interesting though, after the GM fall-out, was that while we saw spread widening across the curve, sovereigns, like Italy and Greece widened more than the whole covered bond market. Our market was more stable than the sovereign market.

LD, ECB  The biggest buyers are still Europeans so their views are important.

Developing new investors

JO, Euromoney  Shall we talk briefly about placement and destination of this paper? What developments in the investor base will help drive growth and progress in this market?

ZA, Goldman Sachs  The biggest driver will be getting non-European investors on board. Right now, US-based investors are not investing in euro-denominated issuers. So it's not a covered bond specific story. The Asian investors, whom Lorenz mentioned, are becoming a growing factor in the euro market generally and, because they need to buy so much paper, they have expanded the list of instruments that they buy from government bonds first to Pfandbriefe and then to the rest of the covered bond market. This – especially with the withholding tax issue resolved in Spain – will be a key driver of growth in the market. The other key element that we will soon see developing, especially with the demand from Asian investors, and potentially with demand from US investors, is the dollar-denominated covered bond.

LA, SG CIB  It's difficult to specifically answer questions like: 'What nationality of investor did you sell bonds to?' Pimco is a US company based in Munich. So when we say that the Americans aren't present, the situation isn't quite that black and white.

ZA, Goldman Sachs Yes, Pimco is in Munich investing in the European government market and yes, JP Morgan Investment Management and Merrill Lynch Investment Management are across the street investing in euro paper, but in general, US investors are not big buyers of euro paper.

DB, HBOS  To me the problem with accessing the US is not just investors not liking the euro, it's the insularity of the market and that is caused mostly by regulation: you have to meet their rules to get in. So either you go the 144A route, which is illiquid, or you go the SEC route. I could not see HBOS seeking to become SEC registered even before Sarbanes-Oxley. After its introduction, issuers have to consider the new implications very carefully. So the problem with the US, is you can't reasonably access it.

WHN, Depfa  I do think that there is an education issue here. It took years to convince the Asians to buy the product even though they wanted to move into euros. How hard have we tried to convince US investors? Not that hard yet. In my experience, the first question US investors ask is, 'What's the difference between ABS and covered bonds? Just explain it to me'. ABS they were used to, but they didn't understand the differences between off-balance-sheet and on-balance-sheet securitization. I think that they are keen and that a chunk of the money which went into the agency market in the past, will go into dollar-denominated covered bonds. It's a question of time and education. I'm 100% convinced about that.

ZA, Goldman Sachs  But you need the currency.

WHN, Depfa  I'm very optimistic on that.

DB, HBOS  I think you have to position it next to agencies, and unless you are SEC registered you will not be positioned there.

WHN, Depfa  To be honest, I think it's just their excuse for not buying into the market yet. They all want 144A business.

ZA, Goldman Sachs  I agree with both of you. We will penetrate US investors and it will be through 144A issuers, but the first one to do an SEC-registered global is going to blot out the other ones. Can you imagine KFW and EIB selling 144A bonds into the US? No, they use the global format to do that. Does the Republic of Austria sell a single dollar bond into the US with its 144A? No. But supranational issuers, at the same Libor level, manage to sell into the US.

WHN, Depfa But did KFW and EIB, with their globally-registered, SEC-registered bonds, really reach US investors to the extent they wanted? I think there's another issue: price. As long as the Asians support ambitious pricing and carry issues they make what is a new product for US investors even less attractive. I think looking at the US market as an arbitrage market is wrong. We should not view dollar-denominated bonds as an arbitrage opportunity, we should view them as a key extension of this market. So the first issue will not be the cheapest. But I think when you really have a strong commitment and want to build a US investor base, you can make it, you can really make it: I am 150% convinced.

DB, HBOS  I still think that the time and effort in the States, just because of the way the rules have changed, makes it very difficult.

Surviving a credit crash

JO, Euromoney  Let's move on to something topical. There seems to be consensus that we are in a credit bubble and also a property bubble. What implications does the unwinding of those bubbles have for this market?

DB, HBOS  Well, given the structure of these instruments, and given the fact that the pools are being cleaned up every six months, it would take a crisis of such severity that either the mortgage arrears overwhelmed the pools or the issuer went bust. In either case you have to ask what would be happening in the wider economy.

JO, Euromoney  What is the key sensitivity though? Is it interest rates or something else?

DB, HBOS  First, you must remember that the triple-A stress scenarios go further than anything you've had in the market. That aside, it would be a prolonged period of very high unemployment that would be the biggest problem because at some point mortgage defaults would start to rise sharply.

LD, ECB  I think at that point investors need to start wondering whether a triple-A with a lower senior unsecured rating is less triple-A than one with a high senior unsecured rating. I think it's very hard to figure out what happens to a structured covered bond.

HH, Fitch Ratings  Is there also then a differentiation between the bonds issued under different legislations? For example, the German law arguably values property more conservatively and so protects investors in German Pfandbriefe more than investors in other residential covered bonds.

TB, Allianz  That's definitely a point that we have analyzed in different laws. However, so many other variables come into play – the kind of mortgage, residential or commercial, the macroeconomic side, unemployment, interest rates – that it is hard to say that just one thing gives you more protection.

JO, Euromoney  And you don't think it would have a serious impact on any of these bonds – in other words, the security built into them works?

DB, HBOS  Even if the most extreme scenarios occurred you still have a high level of protection before you're down to the 60% LTV level – or 75% in the case of Northern Rock. Then there is the fact that you should have no arrears at that point. And unless the issuer has actually gone bust, then regardless it will still continue to pay the bonds.

JO, Euromoney  Carlos, Spain has had a property boom like we have here, does it bother you at all with respect to your asset pools?

CS, Caja Madrid  Not really. I think that unemployment is the key. If unemployment doubled then we would probably suffer on the mortgage pool. But right now non-performing mortgage loans are well below 1%, which means that even if unemployment doubled, the non-performing loans figure would still be very low, and we feel very comfortable with the health of the mortgage market in Spain.

HH, Fitch Ratings  And in terms of risk, Lars, are you more comfortable with assets which are, like in Germany, mostly fixed-rate mortgages compared to the variable rates we see in the UK and Spain?

LD, ECB  From a theoretical point of view I would say yes, but at the moment I feel comfortable with nearly every market.

JO, Euromoney  Wally, what about public sector assets? To what extent are they immune from financial stress in the system?

WHN, Depfa  I find it pretty simple to analyze a public sector pool. Mortgages are complex and need complex analysis but the pool behind a public-sector backed bond is made up of rated and liquid bonds issued by governments, regions or cities.

JO, Euromoney  They can print money if they run out or raise taxes.

WHN, Depfa  Exactly, exactly.

HH, Fitch Ratings  Well, sovereigns and regions and cities default.

WHN, Depfa Yes, you are right, but we have never had a non-performing loan in our public sector balance sheet.

Constraints on the market in future

ZA, Goldman Sachs  On the subject of public sector covered bonds, do you feel there's going to be a problem in the other way around – lack of assets?

JO, Euromoney  Especially with Landesbanken paper losing pool eligibility.

WHN, Depfa  I agree that finding the right assets is not easy; but remember that due to the high budget deficits in almost every country in Europe there are huge funding needs on the public sector side. Also, there are a lot of public sector securitizations which are creating more potential assets. So I don't think we will run out of assets quite yet. In fact, the upcoming changes to the German Pfandbrief legislation will reduce the proportion of cover pools dominated by German public-sector assets and create a true pan-European public-sector pool market, like we have in Dublin. This is a huge benefit as it creates a broader diversification.

ZA, Goldman Sachs  Yes, this is a very positive story for investors. Public sector covered bonds are an ideal way to access the European public sector in a liquid format without having to do the analysis yourself. Issuers are doing the analysis and packaging up illiquid loans from municipalities, from government-guaranteed railways or whatever, into liquid benchmark highly-rated instrument. And it's a very beneficial process for the market as a whole.

JO, Euromoney  The issuer chooses marginal credits and illiquid instruments and is paid for creating a triple-A liquid security out of them. But what about the impact of Basle II on those sub-national risks? How do you maintain favourable rating treatment?

WHN, Depfa  We feel confident with regard to Basle II, because it starts with ratings and more than 95% of our assets are rated by a public rating agency. On top of that we do an internal rating based on our own sophisticated credit analysis. Depfa's credit department gives an internal rating to every single asset on our balance sheet.

ABS and Pfandbriefe converge

JO, Euromoney  Covered bonds used to be viewed as a separate asset class, differentiated by having a legal framework that effectively gave them a brand that allowed investors to take certain things about their credit quality for granted. But the ratings agencies are starting to view ABS and covered bonds as a continuum. They simply dismantle each piece of paper to look at the asset pools. So are the markets in future going to blur into one another?

HH, Fitch Ratings  Well, certainly the cover pool analysis is the same, whether it's a cover pool or a securitization.

JO, Euromoney  Is there not value to the investor in the special feature of covered bonds that you can call both on the assets and the issuer as security? Can you really treat that on a continuum with other ABS?

ZA, Goldman Sachs  I think the investors in each of the asset classes are extremely different and extremely segregated. Even if one institution is investing in both types of asset, it's definitely a different portfolio. One is a highly liquid, government surrogate trading instrument, and the other is a structured credit play. So yes, investors in Pfandbriefe value that feature highly whereas an ABS investor would not so much.

TB, Allianz  I think we are different. The issuers, assets and structures in each of the markets are very comparable.

ZA, Goldman Sachs  So you see that convergence? Are the markets similar enough that you have both ABS and covered bonds in the same portfolio?

TB, Allianz  Yes we have both instruments in the same portfolio.

LA, SG CIB  Under Basle II, mortgage assets are going to have a lower risk weighting. Will that encourage banks to keep mortgage loans on balance sheet and issue more covered bonds rather than securitizing them?

DB, HBOS  I think there is a volume constraint. It would be difficult for us to issue £12 billion in the covered bond market. If we issued a more acceptable £3 billion or £4 billion of covered bonds a year, we would be left with having to issue £8 billion which would include securitization.

ZA, Goldman Sachs  But it's going to become less efficient to issue securitizations versus covered bonds.

DB, HBOS  I don't think so.

ZA, Goldman Sachs  It will if the risk weighting goes from 50% to 10%.

DB, HBOS  Yes, but you're only looking at funding. There is also a pricing issue. What price would you have to pay to get £12 billion away in the covered bond market? Also, many of the investors will be banks who will have the same capital requirement for both ABS and covered bonds where at present it is 50% for securitization and 10% covered bonds, except for the UK where it's 20%. The two markets are not the same: you're still talking about different risks. On covered bonds you have two sources of comfort and on securitization just one – straight assets. So although investors may hold both types of security, they still price them differently.

WHN, Depfa  I think the question is: if you go into such a deep analysis on every issue then does that remove the differentiation between covered bonds and Pfandbriefe that we initially thought existed by virtue of the legal framework? If you believe, as I do, that investors still do place value on the legal frameworks, and use them as a way of not having to do issue-by-issue collateral analysis – most investors do not have the manpower to do that – then why not go the whole way and have a harmonized European covered bond law?

DB, HBOS  But the law only makes it legal for you to exercise your right to the assets. It doesn't describe what those assets are or how they've been originated?

JO, Euromoney  No, but investors use them as shorthand – they know that conforming to the laws means that the collateral is of a certain type and quality and quantity.

WHN, Depfa  The issuer can only include certain assets in the pool, otherwise it's not legal. So you have a homogeneous, triple-A product which allows the investor to focus on the issuers' business model. What are they doing? Can they make money? Is it stable business?

DB, HBOS  But if you have too tight origination criteria, then you may prevent access to a large number of potential issuers. You need to get new issuers into this market and widen the investor base, hopefully as a result of there being new issuers. Yes, you need to maintain the triple-A nature of the market, but not with such tight criteria that you only allow certain big issuers into the market.

JO, Euromoney  It doesn't stop the smaller players, it just obliges them to over-collateralize their bonds in certain ways.

WHN, Depfa  Exactly, yes.

DB, HBOS  I'm just saying that a harmonized law could put barriers to growth in place. If you have a pan-European law, what does that actually do to the underlying laws in each country? Does it result in contradictions and create a bigger problem? You can't be too rigid.

JO, Euromoney  What would you as investors prefer?

TB, Allianz  For investors it makes sense to have the opportunity to choose between different laws and between different issuers.

HH, Fitch Ratings  It's unlikely we'll have ever a unified framework because of the differences in the underlying legislation in the different countries. But one initiative, the capital adequacy directive, does look like a way of identifying covered bonds in future. Lars?

LD, ECB  I think already the markets are not much different but yes you can use the capital adequacy directive rules as a sort of global definition of what is a covered bond . But as to whether it leads in the end to a unified market, I have no idea, to be honest.

HH, Fitch Ratings  The problem may be, though, that from today's three or four criteria we will be moving to pages and pages of rules. Is that bad for the market?

DB, HBOS  I think the more rules you have, the less the market will develop as it becomes too difficult to understand. Also, it's hard for laws or rules to take everything into account. There may be great assets that you should be able to use, but they can't become part of a covered bond because of too strict criteria.

Future new issuers and jurisdictions

JO, Euromoney  Do we expect in Europe, including Britain, the appearance of any further substantial issuers in the next five years that we can predict at this point?

ZA, Goldman Sachs  There are a number of issuers and jurisdictions coming: Scandinavia and Benelux will be interesting. We have more issuers from Germany coming as well as Italy.

DB, HBOS  There is debate about Australia too.

WHN, Depfa  Singapore and Asia will be interesting too.

LA, SG CIB  And bank asset/liability managers are certainly looking at covered bonds.

JO, Euromoney  And what do they expect in terms of market size?

ZA, Goldman Sachs  I think we'll be looking at a €200 billion market roughly.

WHN, Depfa  The forecast for this year is €130 billion new issuance. Last year we had €112 billion. That's European covered bonds.

ZA, Goldman Sachs  If you include all the non-jumbo you probably get to €170 billion.

WHN, Depfa  The clear development will be that the amount of mortgage-backed Pfandbrief will rise, and new issuers will enter the market to issue mortgage-backed Pfandbrief. Landesbanks as collateral will disappear and so public sector covered bonds will have scarcity value.

LA, SG CIB  What about using new asset types to back covered bonds – credit cards or auto loans or things like that?

WHN, Depfa  There has been talk in Germany about that.

DB, HBOS  The problem is that the much smaller asset pools and higher turnover make it hard to ensure you've sufficient assets for the life of the bond – especially as covered bonds tend to be longer-dated than ABS.

LA, SG CIB So what about public issuance, like future tax receipts. Belgium is looking at doing an ABS of future tax receipts.

DB, HBOS And Portugal did one.

JO, Euromoney Our time is up. Thank you all very much. 

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