Covered Bond Fight Takes New Turn as Danes Target Germany

Denmark is in talks with some of Europe’s most powerful governments to ensure a plan to give its covered bonds second-class liquidity status is dismissed.

Economy Minister Margrethe Vestager said a meeting in Berlin this week with German Finance Minister Wolfgang Schaeuble to discuss the merits of Denmark’s mortgage-backed covered bond market was “very positive.” In her search for allies across Europe, Vestager says similar meetings have been arranged in Paris and Warsaw.

Denmark has been in crisis mode since it emerged in November that the European Banking Authority would recommend reserving the highest liquidity status for government debt. The proposal threatens to trigger a sell-off of Denmark’s $550 billion in mortgage-backed covered bonds, which the nation’s banks rely on for liquidity buffers. Though the final decision will be made by the European Commission in June, Vestager said Denmark won’t accept an outcome that hurts its mortgage market.

“If worst comes to worst, we’ll be able to mobilize if the commission doesn’t rule in our favor,” Vestager said yesterday in an interview in Copenhagen. “That will be a very tough confrontation.”

Liquidity Tests

Covered bonds were deemed to be as liquid as most government debt in an October report by the London-based EBA. The authority’s decision to ignore its own technical findings puts it in line with 2010 rules set by the Basel Committee on Banking Supervision, which require banks to limit covered bonds to 40 percent of their liquidity buffers, booked at 85 percent of their market value.

“This segmentation clearly creates disadvantages for banks in countries whose governments have little government or agency debt, as in the case of most Scandinavian countries,” Bert Lourenco, HSBC Bank Plc’s head of rates research for Europe, the Middle East and Africa, said in a note. “With regulators seeking to apply rules uniformly, it seems that the EBA will not provide exemptions despite industry lobbying.”

The commission said last week it will take into account the particular strengths of Denmark’s covered bond market as it reviews the EBA’s proposal.

The EBA’s guidance is advisory and the commission will prepare standards that should “specify which assets qualify as being of high and extremely high liquidity/credit quality,” Chantal Hughes, spokeswoman for EU Financial Services Chief Michel Barnier, said in an e-mail last week.

German Support

Before announcing its decision, the commission will spend the next few months consulting European Union member states and the European Parliament.

Should the commission decide to follow the EBA’s guidance, Denmark could try to overrule the EU’s executive arm by rallying support in the European Council of Ministers. Having German backing in that event will be helpful, Vestager said.

“The way I read the German position, they have the same view of Danish covered bonds as we do,” Vestager said. “It’s very important that the Danish position is well-understood in some of the most important countries.”

Denmark’s covered bond market is almost four times the size of its stable AAA-rated government debt market, and more than 1 1/2 times the nation’s $340 billion gross domestic product, central bank figures show. Denmark’s public debt will reach 43.7 percent of GDP this year, compared with a euro-zone average of 95.9 percent, the EU Commission said Nov. 5.

Possible Compromise

The EBA in December opened the door to allowing the inclusion of covered bonds with a minimum issuance of 500 million euros ($680 million) into the top liquidity bracket.

Such a solution would be acceptable for Denmark’s financial system, Ulrik Noedgaard, head of the Financial Supervisory Authority in Copenhagen, said in an interview. The FSA estimates that more than 80 percent of Danish mortgage bonds, measured by volume, would meet that criterion.

“I’m not ruling it out,” Vestager said. “We just have a very simple agenda for now: we’re not considering compromises yet.”

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