Standard and Poor’s said last year that it was planning to introduce new criteria for swap counterparties in structured finance and covered bonds. Definitions are being tightened, collateral requirements tweaked, and in the furthest-reaching change, documentation will have to show that replacement counterparty is in place in the event of insolvency or downgrade of the original counterparty.
The new criteria were due to be implemented on January 17. But at the eleventh hour the agency announced that, while it was pressing ahead with new structured finance counterparty criteria as planned, it would postpone the new criteria for covered bonds.
Bankers have been left mystified by the decision — and by the agency's justification for the delay.
Explaining its actions, S&P said that covered bonds were dual-recourse and noted that "covered bond programs may include multiple counterparties”.
This is hardly news, even to those with only a rudimentary understanding of covered bonds. So market participants are left trying to work out what might really be behind the decision.
It could just be, of course, that the agency is giving covered bond issuers a little more time to get their house in order. After all, unlike structured finance borrowers, covered bond issuers have barely reacted to S&P's initiative — even though the consultation document has been out since May 2010. But they would in any case have had six months to submit amended documentation following introduction of the new criteria — as structured finance issuers now have.
But it could also be that covered bond issuers have no intention of making the necessary changes. According to one memo sent out by a covered bond analyst this year, issuers will simply drop the agency if they can, rather than try to jump through the new hoops.
For many, the new requirement for a replacement counterparty is nigh on impossible to achieve. The reality is that there are fewer eligible swap counterparties around, and even fewer who want this kind of business — no matter what the fee.
That fact obviously didn't escape Fitch and Moody’s, who only require alternative swap provision to be made on a “best efforts” basis.
That approach is a cop-out, of course, as it gives issuers enough ‘wobble room’ to bluff their way through. For its part, S&P says it “may supplement the application of the criteria...with additional criteria” — suggesting that a softening may prevail.
By initially setting such high standards, S&P has put itself in something of a no-win situation. Either it keeps the strict criteria and risks losing market share when about 80% of covered bond programmes get hit with CreditWatch Negative actions. Or it softens the criteria and risks being criticised for putting commercial interest before fundamental credit analysis.
That's the problem with occupying the moral high ground: it does leave you rather exposed when a storm blows up.