Germany, Denmark Advance in Fight to Save Covered Bond Label

  • EU Commission seeks to create single European market
  • Danish industry group doubts benefits of harmonization plan

Bowing to pressure from Germany and Denmark, the European Commission said any steps to create a single covered bond market would entail shielding the label against copycat assets that might threaten the $2.6 trillion industry.

Efforts to create a single framework for covered bonds -- a “cornerstone of long-term finance” -- would seek to “avoid contagion from lower quality instruments in a crisis,” the commission, the European Union’s executive arm, said in a Sept. 30 consultation paper. The term’s use would be limited to instruments that fulfill criteria set by regulators, it said.

Denmark and Germany, the world’s largest covered bond markets, have warned against sacrificing the strict regulations that govern their industries to create a single market. Easing requirements would risk undermining investor confidence in secured debt, which emerged unscathed from the financial crisis. Banks holding the bonds get favorable capital treatment.

“What I don’t want to do in any of these things is risk upsetting markets that are working well for a potential benefit that you may not be able to realize for some time,” EU financial-services chief Jonathan Hill said in Brussels on Thursday. “I think it is sensible there not to rush, to try and get it right because there are important balances to strike.”

Skeptical Response

The covered bond market “works very well in some countries, extremely well in Germany, Denmark,” Hill said. “We want to expand it, but one of my other things always, is we do need to consult on that to see what the elements are of models that work well that you can export.”

The commission’s message failed to erase skepticism, not least because it left open the option of using business loans as collateral. Most bonds are backed by mortgages or public sector loans.

“We’ll of course go into this with an open mind and emphasize the good features of the Danish system, but we are a bit skeptical about harmonizing the covered bond systems,” said Karsten Beltoft, head of the Danish Mortgage Bankers’ Federation. “There are good reasons for having different systems in different countries, and I am sure that many countries believe they have the best system. We do.”

Funding Options

A variety of factors such as taxation shape markets, which addressing only financing can’t resolve, Beltoft said. “As long as those aren’t the same in all countries, I think it will be difficult,” he said.

Hill has emphasized the need to increase the funding options of small and medium-sized companies. Their reliance on banks left them particularly exposed as lenders shrank balance sheets in the financial crisis.

In its consultation paper, the commission queried whether it’s possible to identify “prime” loans to small and medium-sized businesses that could be used as assets in cover pools, even as it sought to appease industry concerns about diluting the brand.

Global covered bond issuance climbed 50 percent in the 10 years through 2014, to 2.5 trillion euros ($2.8 trillion), according to the European Covered Bound Council. The industry group has suggested introducing a new product for business loans.

Covered Pools

Legislation governing which institutions may issue covered bonds vary across countries. The same applies to setting requirements for covered pools, insolvencies and disclosure. Those differences make it difficult to create a market that stretches across Europe, according to the commission. Pricing differences already exist between countries, it said.

Under its proposal, European regulators would certify covered bonds, and a third party would monitor collateral. Loan size to asset value ratios and over-collateralization requirements would also be set and monitored regularly. Such measures could be taken voluntarily or through legislation, unlocking “a number of potential benefits for participants in covered bond markets and for the general economy,” the commission said.

Denmark would prefer a voluntary system that excludes business loans as collateral, Beltoft said. According to Ane Arnth Jensen, head of the Association of Danish Mortgage Banks, a framework incorporating Danish features would obviously be acceptable, though whether that’ll happen remains to be seen.

The commission’s work “speaks for a more principles-based approach, but it is difficult to say if it will be fruitful,” Jensen said. Denmark “will invest in the process,” she said. “It’s just hard to say if it will turn out positive, because it could turn the other way.”

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