Sweden Says Legal Mess Faces Covered Bond Market Amid EU Plans

Any effort to enforce a single rule book on Europe’s covered bond markets is likely to result in legal chaos, Sweden’s financial regulator is warning.

Imposing new, European harmonized rules makes no sense given that insolvency and foreclosure laws will remain national, said Uldis Cerps, executive director for banking at the Swedish Financial Supervisory Authority.

“This will be very difficult to be implemented in practice,” Cerps said by phone on Jan. 5.

The European Commission wants to create rules that support the spread of covered bond financing after the securities proved resilient to the financial crisis. The idea is to identify the best features of the biggest markets and use these as a starting point to create one big harmonized market across Europe.

The commission took comments through Jan. 6 on two proposals: voluntary compliance with its recommendations or direct legislation including, potentially, a new region-wide framework. But Sweden opposes a one-size-fits all model, Cerps said.

“Harmonization might conflict with other national legislation which is not proposed to be reformed such as insolvency laws and resolution,” Cerps said.

Denmark and the Netherlands have joined Sweden in calling for the commission to exercise caution. Price disparities in Europe’s covered bond markets that emerged during the financial crisis “largely” reflected sovereign bond yields, rather than differences in local legislation, the Dutch central bank and Ministry of Finance said in a Jan. 6 statement.

“Abandoning one covered bond issuer model in favor of another is likely to be a very costly, difficult and protracted process,” Denmark’s three banking and mortgage associations said in a joint December letter.

Sweden’s covered bond market is among the world’s five largest and is six times as big as Portugal’s, according to industry data. Swedish banks depend more heavily than most in Europe on market funding because deposits are relatively low. Lenders have more than 2 trillion kronor ($233 billion) in securities outstanding, about half of which is in covered bonds, according to FSA data. Demand for shorter-dated paper drove rates down below 1 percent in 2015.

Sweden has found support at the European Banking Authority, the region’s financial regulator. The London-based agency said in October that applying a standardized concept of mortgage lending value, for example, could disrupt markets, especially in countries that already have “rigorous” criteria for determining how much buyers can borrow against a property.

The European Covered Bond Council, an industry organization whose members represent more than 95 percent of the 2.5 trillion-euro ($2.7 trillion) covered bond market, says countries with strong frameworks probably would reject efforts to impose a new regime.

“Why should they abandon their (benchmark) position and issue covered bonds under an untested new framework?” the council said in a Dec. 16 response to the European Commission proposals.

Sweden’s covered bonds have managed to avoid a slump in liquidity that has plagued some other fixed-income markets. A review found liquidity hasn’t fallen markedly in recent years, according to the Swedish FSA’s December financial stability report. The agency also said it’s opposed to broadening the collateral that banks are allowed to use to include, for example, loans to businesses.

Non-legislative initiatives “have the biggest chance of facilitating what the European Commission wants to achieve,” Cerps said. “It is most important that national flexibility be retained and we instead look at best practices.”

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