Investors expect more focus on covered bonds in evolving regulation

Covered bonds’ possible role in stoking house price inflation came under scrutiny at a covered bond investor conference in Frankfurt yesterday (Thursday), with panellists saying that further regulatory focus on the asset class akin to that seen in Norway is only to be expected.

At the event, organised by the ICMA Covered Bond Investor Council and The Covered Bond Report, investors and a representative of the European Banking Authority (EBA) discussed covered bonds’ position in macroprudential regulation, drawing on Nordic and Spanish experiences.

Georg Grodzi, head of pan-European credit research at Legal & General Investment Management, said that overuse of covered bonds can fuel a rise in property prices — citing Ireland and Spain as examples — and said that it is important “to be honest” about this potential impact. Regulatory authorities are entitled to monitor overall leverage in an economy, and, as a funding tool contributing to this, covered bonds would legitimately come under their focus.

“If there is a property bubble it won’t be covered bonds’ fault,” said Grodzi, “but covered bonds are not a guarantee that things will remain under control.”

Claus Tofte Nielsen, head of position management allocation strategies at Norges Bank Investment Management, said that investors should be “relaxed” about and understand that regulators may turn to covered bonds in a bid to try to dampen house prices. However, he noted that politics can influence how regulators tackle overheating property markets, so investors should be mindful of this as well as the role played by the availability of sources of cheap funding. He gave as an example the introduction of legislation in Denmark that allowed interest-only mortgages, which some would say turned out to be a mistake, he added.

Other panellists pointed out that covered bonds are only one piece of the puzzle. Christian Moor, policy advisor, securitisation and covered bonds at the European Banking Authority, said that loose underwriting standards and poor risk management are other contributing factors.

Later, Morten Bækmand, head of investor relations at Nykredit Realkredit, gave a mixed prognosis on the wider regulatory front. He said that whereas a previous examination of pending regulations had thrown up 10 potential ways for Nykredit to be put out of business, after recent developments “we can only be killed three or four times”.

Florian Eichert, senior covered bond analyst at Crédit Agricole CIB, said that regulation remained uppermost among issues that investors are grappling with based on his conversations with them.

Bækmand noted that a “key” decision would be the final outcome over what assets are eligible as top level LCR assets after the EBA has completed its work on this. Bækmand was optimistic about Danish covered bonds’ fate, noting that the industry had a lot of data to back up its case.

Jens Tolckmitt, chief executive of the Association of German Pfandbrief Banks (vdp), said that a major issue that needs to be tackled is the way in which European-level regulatory initiatives can be contradictory, and he called for greater examination of the interaction of different regulations.

Nykredit’s Bækmand agreed with this, citing two examples. He said CRD IV induces banks to raise more longer term funding, but that Solvency II penalises insurance companies buying long term assets, and that the authorities want liquid markets but are introducing the Financial Transactions Tax, which Bækmand said “will kill” liquid markets.

He warned that such muddled regulation would “sow the seed for the next piece of trouble”, saying it was likely to result in activity being driven into the shadow banking sector, concluding: “Watch this space.”