GlobalCapital: It looks like covered bonds will go to Level 1 of the LCR and non-EEA bonds could come in as a Level 2A asset? How does this change things? El Amir, UniCredit: It is good news. A lot of the analysis on covered bonds showed that they were as liquid as sovereign bonds, so including them in the Level 1 was the right decision. I think it will incrementally improve demand but I don’t think it is just going to be exponential just because most of the market assumed they were going to be level 2A. Our liquidity portfolio had been buying a significant amount of covered bonds already, so the fact they’re now Level 1 isn’t going to change our behaviour hugely.
Ségur, La Banque Postale AM: It would be a very positive thing for covered bonds and particularly for Nordic and Danish banks. In terms of demand, it would increase the interest for banks to invest in covered bonds and would probably lead to a spread tightening. We don’t really see significant changes on the supply side.
Pimper, Commerzbank: The proposal to include highly rated European covered bonds in Level 1B underpins the actual market reality which is that covered bonds, from a liquidity perspective, trade close to sovereigns — as observed by the EBA.
This is also good news for countries like those in Scandinavia where the covered bond market is bigger than the sovereign market. And the fact non-EEA bonds are likely to be included under Level 2A will provide a good opportunity for European investors to diversify their portfolios.
Mugat, AGI: Draft LCR rules have already had positive impact on bank demand, and besides the attractiveness of euro funding versus the dollar, non-European banks will be keen on increasing supply as Bank of Montreal and Toronto Dominion recently showed.
Costa CGD: The favourable LCR treatment of covered bonds should in theory increase demand and may induce banks to issue more. But I don’t expect a major impact in the demand for EEA versus non-EEA bonds given that the only segment of investors for which the LCR rules are relevant is bank treasury or investment portfolios.
Coyne, NAB: We already see significant sponsorship from bank treasuries but we expect that to expand if the draft LCR rules come into effect. When you add net negative supply and the potential for increased LCR demand, it just adds to the improved technical backdrop.
Boehm, Pimco: For our day-to-day business LCR eligibility is not the top investment criterion. But for other participants such as banks which are a relatively large constituency of covered bond investor demand, we expect this is positive for demand of Level 1B assets at the margin.
Gotrane, Caffil: The LCR treatment of covered bonds is already driving up demand. When we look for example at French covered bond issuance this year, 40% of demand came from bank investors, which it is partly a consequence of LCR rules.
We don’t expect the difference in LCR treatment between EEA and non-EAA covered bonds to have of a big impact. There are already differences in regulatory treatment between the two segments today, for example, with respect to ECB eligibility. Obviously, the investor base will be different for EEA and non-EAA covered bonds, but I wouldn’t expect any other impact on the market.
Looking ahead, it is not just going to be the LCR treatment of covered bonds that drives the market. Investors have to choose between covered bonds and other assets for their liquidity portfolios, and they’ll look closely at the LCR treatment of each of these assets. So in the end, what’s going to be key is the relative LCR treatment of covered bonds compared to other assets classes, for example certain RMBS tranches.
GlobalCapital: The process of drafting LCR regulation from a covered bond perspective seems to been quite changeable and unexpected at times?
Burmeister, DeAWM: We’ve had some hiccups with the LCR like the proposed introduction of issuer ratings. There is this tendency to introduce more complexity in regulation. That’s the nasty thing for me as this draft was falling out of the sky, in terms of merely understanding the motives and motivation for introducing it.
It’s the same with securitization in the sense that you have this potential ECB purchase programme and it wants to support the market. But that could be difficult and very complex without considering a change in the regulatory requirements. As this is being discussed by regulators right now you can’t say for sure how things will end up.
GlobalCapital: Do you think the implementation of BRRD in January 2016 will affect covered bonds?
El Amir, UniCredit: The market has not in my view fully appreciated the potential dangers under bail-in but banks are much safer entities than they were five years ago. And loss-absorbency buffers that are being introduced by the regulators means senior is in a stronger position, allowing people to look at them much more on a probability of default basis than a loss given default point of view.
Senior holders have so far come out unscathed and it has made the market a bit complacent. But if a bank does go under and the senior takes a haircut you’ll see everything gap out very quickly.
Coyne, NAB: The exclusion of covered bonds from bail-in in Europe is a clear positive for that product specifically. There is currently no indication from our regulator that bail-in is on the regulatory horizon in Australia. However, the planned Financial System Inquiry will lay the blueprint for the financial system in Australia for the next decade and we await the key recommendations in that report.
Costa CGD: The higher risk premium required by senior investors to compensate for the bail-in risk will depend on the creditworthiness of the issuer and its funding structure, particularly on the proportion of loss-bearing liabilities. A bank whose liabilities are not predominantly bail-in-able might face increasing costs when issuing unsecured debt, making it more appealing to issue covered bonds.
Gotrane, Caffil: The problem for the market is that the resolution regime is still taking shape and a lot of questions have not yet been answered. It is therefore no surprise that we don’t have a real consensus on what the spread differences between senior debt of different issuers should be. The same holds for the spread between senior and covered bonds of the same issuer. We sometimes see differences from one issuer to the other which seems difficult to explain.
GlobalCapital: Do you expect to see differences from one covered bond regime to the other under the BRRD?
Gotrane, Caffil: There could be differences. For example, we don’t know what will happen with voluntary OC in case of a bail-in. Covered bond investors may be in a stronger position under legislative frameworks like in Germany or France than in other markets where regulators may end up with more powers to decide on a case-by-case basis.
Take, for example, common law covered bond structures that rely on a guarantee provided by the covered bond vehicle. This guarantee is triggered by the default of the sponsor bank. However, we don’t know yet how such a mechanism would work in case of a bail-in. So overall, reading the fine print will become more and more important.