Norddeutsche Landesbank has just issued the first ever Flugzeugpfandbrief, or Aircraft Pfandbrief. The deal was always likely to be a success, given the liquidity in the German banking sector, the quality of the issuer and the favourable capital treatment for Pfandbriefe for those savings banks for whom the issuer acts as a central bank.
But it has raised uncomfortable questions about precisely what is a covered bond. At a time when there is growing economic pressure to expand the range of eligible assets for covered bond collateral, this is pretty fundamental.
The aircraft assets backing NordLB's deal are registered, so it should at least be possible to enforce security across national boundaries. On that basis it could be argued that they are a logical extension of the mortgages that make up the traditional collateral for covered bonds.
But even though Flugzeugpfandbriefe have Pfandbriefe in the name, they are not eligible for preferential treatment under Europe's Capital Requirements Directive (CRD).
Regulators may well be less inclined to believe that security is enforceable on an expensive plane sitting on a runway in the middle of nowhere than on a much lower valued full recourse, first lien loan that is secured on an owner-occupied residential property in Kilburn.
The exclusion might not be surprising, but it does matter. It raises a question over whether the bonds would be eligible for banks to hold in their liquidity buffer under Basel III, for instance. It is also not clear whether insurance companies would necessarily be entitled to the favourable capital charge that traditional covered bonds attract under Solvency II.
Bankers report that officials at the European Central Bank have privately expressed misgivings over whether ship Pfandbriefe are true covered bonds. If that's true, you would certainly expect a fight over aircraft-backed bonds.
The European Covered Bond Council, meanwhile, is trying to establish an industry standard through its Label initiative. Bankers reckon it would gladly chuck ship Pfandbriefe under a bus to secure better treatment for the rest of the market.
As it happens, the Danes and the Germans have not been able to agree on transparency standards for what is a small and largely private market. So for the moment, ship Pfandbriefe stay out of the Label.
But the debate over definitions rages on. Covered bonds generally receive very favourable regulatory treatment because of the highly regulated nature of the market. As issuers push for ever greater variety of collateral, the industry needs to come up with a credible and robust definition of the asset class. A failure to do so will put the entire brand at risk.