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Covered bonds: It’s credit, pure and simple

The covered bond market has not behaved in the way investors had been led to believe it would. It’s time to realize that covered bonds are not the golden child of the bond family.

Despite the relentless commentary of covered bond participants on the relative benefits of their product in times of financial stress, severe difficulties continue to hamper the market-making process, and the secondary market remains in virtual paralysis. Various measures implemented by such bodies as the European Covered Bond Council (ECBC) since the credit crunch, such as the tripling of bid-offer spreads and the splitting of the market into core and non-core jurisdictions, have not had the desired effect of reinvigorating the stalled market. Although some issues have enjoyed small measures of success in the primary market, most notably those from German Pfandbrief issuers, the market remains illiquid and trading of covered bonds in the secondary market is non-existent.

Of course, the covered bond market is not alone in this. All markets are at present facing difficulties. From triple-A rated government bonds through to high yield, almost every market is experiencing the same thing. But the difference with the covered bond market, as in government bonds, is that there is mandatory inter-bank market-making. The idea is that no matter what’s going on elsewhere in the markets, covered bonds should remain liquid in the inter-bank market. That way, the secondary market remains open.

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