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FIGCovered Bonds

Green shoots in the covered bond market

Until recently, green covered bonds were always more of a theoretical discussion than one that had taken root. But they could be just what the central bank-oppressed market needs.

But on Monday, the asset class took a giant leap forward as Berlin Hyp issued its €500m seven year Grüner Pfandbrief, a transaction that was placed with many new types of investor.

The European Central Bank’s purchase programme has squeezed the life out of covered bonds.

After six months the programme has now reached €72.6bn, far in excess of the available net supply. According to Barclays research the euro system has displaced €85bn euro covered bonds from existing holders.

These investors have had to find alternatives to their covered bond holding, some of which may have offered a better return. This shouldn’t be too difficult given that almost 27% of the covered bond market has a negative yield and almost 95% yields below 0.50%, according to DZ Bank research.

In the face of this mass exodus, issuers must do all they can to hold onto buyers, so anything that helps to differentiate the product and appeal to a wider audience is going to be worth examining. With 48% of Berlin Hyp’s deal placed to a differentiated group of new socially responsible buyers, it seems Green covered bonds could be one answer. They’re also good for the planet.

Socially responsible investors coming into the book made the bond one of the most subscribed and broadly distributed of all German covered bonds issued this year — 70 investors in a €2bn book. The issuer achieved this feat despite the paltry 0.125% coupon, the lowest ever for this tenor.

But if traction in green covered bonds is to really take hold it might be worth paying attention to the recommendations in a report to the European Commission.

Two weeks ago a Commission-sponsored report aimed at encouraging growth in green covered bonds and securitizations, Shifting Private Finance towards Climate-Friendly Investments, was published. The authors of the report advocated more standardisation of contracts and project evaluation structures as a key to the market’s development.

The European Banking Authority is now working to integrate green covered bonds in its next best practice guidelines. The report to the Commission suggested there is even a chance mortgage rates may be adapted to reflect the improved valuation performance of energy efficient homes. It says deals backed by green mortgages could be better collateral than other mortgages because of their more favourable bank loan valuation treatment. The report also talks about a potentially lower capital charge, which could be the shot in the arm needed to rebuild the securitisation market.

And, if you thought collateral would be difficult to find, think again. Virtually all new home builds in the UK, Germany and the Netherlands are built to such high quality environmental standards that they’ll qualify as green.

A shift to environmentally friendly collateral could be just what secured financing needs. Let's turn the lights green for covered bonds.

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