Germany, France Join Denmark to Fight Basel Liquidity Rules

European Union’s Financial Services Chief Michel Barnier
European Union’s financial services chief Michel Barnier said Danish concerns on the implementation of liquidity rules have been “noted” and “examined.” Photographer: Hannelore Foerster/Bloomberg

Denmark is teaming up with Germany and France to fight rules it says will penalize the world’s third-largest covered bond market.

“It’s a matter of gathering support and finding friends,” said Louise Mogensen, a department head at the Copenhagen-based Economy Ministry, in a March 7 interview. “It’s still too early to say that we’ll be successful; the commission has shown it’s ready to listen to our points.”

Denmark wants the European Commission to change rules set out by the Basel Committee on Banking Supervision that the Nordic country says will force lenders to sell off mortgage bonds. Ane Arnth Jensen, director of the Association of Danish Mortgage Banks, has called Basel’s reluctance to assign mortgage debt the top liquidity status “grotesque,” while Nykredit A/S Senior Vice President Jesper Berg says Denmark would face a credit crisis “the likes of which this country has never seen” if the rules aren’t changed.

A Dec. 20 joint letter from Denmark’s Economy Ministry, the German Finance Ministry and France’s Ministry of Economy, Finances and Industry obtained by Bloomberg shows the European Commission is working on a model that the three countries say “adequately reflects” the liquidity status of covered bonds.

The liquidity standards are “an essential issue,” said Chantal Hughes, a spokeswoman for EU financial services chief Michel Barnier, who is leading the commission’s work to implement the Basel rules. “Given the problems linked to liquidity we saw in the recent crisis, it is important to get this right.”

Meeting Tomorrow

Barnier is likely to discuss the issue with Danish Economy Minister Brian Mikkelsen in Brussels tomorrow, Hughes said. Mikkelsen will be in Brussels to attend a scheduled meeting of European Union ministers responsible for enterprise and industry.

“We’re in continuous contact with the European Commission,” Mogensen said. A directive on Basel implementation in Europe “is expected by the end of June and in the meantime we’re working to influence the final shape the draft takes,” she said. “Basel hasn’t created rules, as such, it’s up to us in Europe to decide what approach works best here.”

The letter concludes that the model, which isn’t disclosed, “should be specified in 2014 within the capital requirements directive as a political decision through the co-decision procedure” with the European Council and European Parliament.

Observation Periods

“The Basel committee has said that its liquidity rules will be subject to observation periods before they are introduced, and we intend to make full use of them to address any unintended consequences,” Hughes said. “In the meantime the Commission is evaluating how best to incorporate technically the liquidity standards into EU legislation.”

Denmark’s mortgage bond industry “greatly appreciates the efforts by the authorities and the commission to find a solution,” Nykredit’s Berg said in an e-mailed response to questions. “Our expectations are that at the end of the day, a solution will be found that will address our concerns.”

Mogensen declined to comment on the model’s details. While Basel’s deadline for implementing the liquidity rules is 2015, the European Union has yet to legally commit itself to a timeline. The model proposed allocates asset classes based on “a number of strict liquidity criteria,” the letter said.

“We’re very much in favor of strict capital requirements and support the inclusion of high-quality capital in the liquidity ratio,” Mogensen said. “We don’t want to dilute or weaken the existing proposal. We want a solution that doesn’t assign an asset a liquidity value based on its name, but on the quality of the asset.”

Liquid Market

Denmark’s lenders, which hold more than half the country’s $490 billion of mortgage bonds, would be forced to sell off holdings to comply with Basel’s 40 percent cap on using the top-rated securities as liquid assets, according to Arnth Jensen. Basel, which says the rule will provide lenders with more liquid assets to guard against times of financial stress, doesn’t place any limit on sovereign-debt holdings.

Denmark’s mortgage bond market is about 1 1/2 times the size of the country’s economy and more than seven times the size of the government bond market, according to the central bank. Denmark, which isn’t one of the Basel Committee’s 27 members, is one of the most vocal critics of the liquidity rules.

Outperformed Bunds

Trading in Denmark’s covered bonds -- securities backed by the cash flow from a pool of mortgages -- rose during the financial crisis, both in the total value of securities traded and in the median size of individual trades, central bank data show. It was easier to trade short-term mortgage bonds than government notes, the bank estimates.

Danish mortgage bonds have lost 0.6 percent this year, according to an index that doesn’t account for reinvested interest. German debt with a maturity of more than 1 year has lost 2.8 percent in price over the same period, according to a Bloomberg index.

Denmark’s government-bond market is too small by about 300 billion kroner ($56 billion) to bridge the liquidity gap the Basel rules would create, Arnth Jensen said in a December interview.

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