It has been more than a year since the Monetary Authority of Singapore (MAS) introduced covered bond regulation into the city state, a move that had the potential to deepen Singapore’s debt market, with banks able to issue some S$25bn-S$30bn ($18.4bn-$22.1bn) of covered bonds.
Fourteen months down the road, the numbers tell a very different story. What was expected to be a multi-billion asset class has so far failed to even attract a single issue.
The lack of issuance is down to a number of factors. One is the fact that Singaporean banks do not really need the cash. They are among the best capitalised in the region and are able to enjoy low funding costs for senior unsecured debt thanks to their high credit strength.
The second reason is uncertainty surrounding the framework itself, such as whether banks will be allowed to hold the assets on their balance sheets.
Thankfully, the MAS is tackling these issues head-on with the latest consultation, along with other amendments that will improve the liquidity of the cover pool — such as allowing more than 15% of assets in cash to refinance maturing covered bonds.
This is a great move by the regulator. But even if the amendments do go through, there will still be a huge hole in Singapore’s cover bond framework — the question of who has first claim on mortgage loans used in covered bonds in the event of a default by an issuing bank.
The sticking point is that Singaporean banks do not have first claim to most of the mortgages they lend out. Instead, it is the state pension fund, the Central Provident Fund (CPF), that has first access.
It is a situation that is unique to Singapore because the CPF allows its members to use a portion of their invested money for other purposes, such as the repayment of mortgage loans. If a homeowner chooses to do so, the CPF will have a priority claim on that home.
The rationale behind this move is to maintain a high home ownership rate, a statistic in which Singapore consistently ranks as one of the highest in the world for the past twenty years. Its home ownership rate of resident households was 90.3% in 2014.
While this system goes a long way to ensuring that its residents have a roof over their heads, it also creates a huge headache for banks as the entire rationale of covered bonds hinges on investors having first priority to assets in a cover pool.
Since the banks themselves do not have first access to mortgages funded by the CPF, investors buying into covered bonds issued by them will, as a result, also be naturally subordinated to the pension fund in the event of a default. This defeats the purpose of buying a covered bond in the first place.
To resolve this confusion, the government needs to introduce legislation in order to prevent the CPF having first claims on mortgages underlying a covered bond. But changing the law takes a lot of time. If Singapore is serious about establishing a covered bond market now, then there are a number of other options it should consider for the time being.
The obvious way, in theory, would be to restrict cover assets to mortgages that are not CPF-funded. But since most mortgages in Singapore are CPF-funded, this is not really feasible. Banks would have few to no assets to pick from.
A more useful option would be to request that the CPF subordinate its claims over the assets to the banks. On top of that, lenders should also obtain explicit approval from the CPF for transferring the mortgages into the cover pool.
These two steps combined could ensure that investors would have full recourse to the assets in the cover pool — and it is understood that there is already some degree of understanding between the CPF and the lenders with regards to this.
But whatever course of action Singapore takes, it needs to do so fast. The longer this drags out, the more questions will be asked how serious the country is about the health of its banks and the development of its debt capital markets.
The consultation paper is a nice step forward and Singapore is very close to having a complete framework for covered bonds. All that is left is to clear up the confusion surrounding the CPF. After all, as they say, possession is nine-tenths of the law.