The Monetary Authority of Singapore (MAS) introduced legislation in 2013, but covered bonds in the city-state have failed to live up to their potential of being a S$25bn ($18.4bn) asset class. So far there has been no issuance at all.
This no-show is not because of a lack of interest from the supply side. Three Singaporean lenders — DBS, OCBC and United Overseas Bank — have been preparing to issue for the past few years in a bid to promote this policy-driven asset class.
What is holding Singapore covered bonds back, however, is a deep-rooted problem: Singapore covered bond investors do not have first claim on the asset pool. This is because 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 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.
This is a huge deterrent for potential investors in covered bonds, as the essential feature of the asset class is the dual recourse structure — to the issuer and to the pool of assets.
“It’s no secret that this is an issue and investors want clarity over what will happen when there’s a credit event,” said Bernard Wee, executive director, international department and financial markets development department, MAS. He was speaking at the Euromoney Conferences Asian Covered Bond Forum held in Singapore on March 10. “But we also need to understand that the CPF board has a duty to safeguard the investments of its members.”
End in sight
In spite of the apparent clash of interests between covered bondholders and the CPF, Wee pointed that the issue could soon be resolved as DBS was in talks with the CPF over a unique structure that could suit both parties. Bankers are optimistic that a breakthrough could come within the next few weeks.
Details of the proposed structure are scarce, although it is understood to allow banks to declare a trust on the assets, which will allow them to keep the assets on balance sheet. This would be similar to Pfandbriefe, the German covered bonds that are the benchmark for the entire asset class.
But it remains to be seen whether the structure will work, since the ability for issuing banks to keep the assets on balance sheet was only proposed in the Singapore's second covered bond consultation paper in January. The consultation closed on February 28 and there has been no update since.
“We’re close to finding a solution but we’re still not there yet,” said Yeoh Hong Nam, senior vice president, head of wholesale funding, DBS, at the same conference. “The obvious reason being that Singapore laws are created like a very tightly knitted carpet that is made to fit for very specific reasons. They are not designed to be changed easily.”
Once the problems are all out of the way, however, Yeoh said DBS will look to issue a benchmark size transaction in either euros or dollars rather than its natural currency of Singapore dollars. “We’re flush with Singapore dollars right now, so we absolutely don’t need any more of it,” he said.
Going euro
Most market participants agree that euros are the best choice for the Singaporean banks since the largest buyers of covered bonds are from Europe.
“For Asian investors, the yields offered by a covered bond from an Aa3/AA-/AA- rated bank like DBS simply don't make any sense,” said one hedge fund manager. “But Europe is a different story because it’s now in a negative yield environment, plus there’s simply been no covered bonds for investors to put their money into ever since the European Central Bank (ECB) started gobbling them up last October.”
Another benefit of selling into Europe would be the advantage in pricing that would be achievable because European accounts are a lot more familiar with covered bonds than investors in Asia, said Ang Suat Ching, head of funding and capital management at OCBC, speaking at the conference.
“For senior bonds we usually issue in dollars, but for covered bonds maybe euros,” she said. “The breadth and depth of that market makes it a good choice.”
Still, more needs to be done to get European accounts interested in unfamiliar credits such as Singaporean banks. With that in mind, DBS, OCBC and UOB have already started meeting European investors over the past few weeks.
More fixes needed
While roadshows will help improve investor familiarity towards the underlying credit, Philippe Hombert, global head of debt capital markets for financial institutions and public sector at Natixis, said that one sure way to drive interest up would be to modify the Singapore framework to be in line with that set out by the European Covered Bond Council (ECBC).
Founded in 2012, the industry body establishes guidelines for the European covered bond market and many jurisdictions have based their individual frameworks on ECBC standards.
As things stand, two important changes would have to be made to the Singapore framework, the first of which would be to promote covered bonds to level one liquidity coverage ratio (LCR) status.
Level one assets such as cash, central bank deposits and government treasuries can be used without limit in a bank’s liquidity buffer and are usually not subject to a discount to their market value, although covered bonds in Europe are subjected to a 70% cap in the buffer and a 7% haircut.
For level 2A assets the restrictions are much higher. They can only be used up to a maximum of 40% in the liquidity buffer, and they are also subject to a minimum 15% haircut.
Increasing the LCR rating of Singapore covered bonds would therefore naturally lead to an improvement in demand from banks, according to Hombert, since they will be a far more important asset to have on balance sheet. That is all the more important since investor access to covered bonds from Europe has become harder since the ECB buyback.
“Singaporean covered bonds would therefore offer a nice alternative for European investors especially those looking to diversify into Asia,” he said.
The other step the MAS could take is to make covered bonds repo-eligible. This would also have a similar effect as increasing the LCR level, since banks would find more uses for them rather than just having them sit on their books. Banks would be able to use the bonds as collateral with the central bank, an option already available to those buying European covered bonds.
“The reason why things have been moving at such a slow pace for Singapore is because Asia has not been under the same kind of financial stress as Europe so there is no need for super safe products such as covered bonds,” said Erik Wong, managing partner, Greater China Capital.
“The impetus isn’t there for it to be rolled out quickly although that doesn’t mean it won’t be needed in the future. When that time comes, covered bonds will be a useful tool to have.”