Furope’s biggest covered bond issuers are turning to Asia to rally support in what they say will become a global challenge to the Basel Committee on Banking Supervision.
The European Covered Bond Council, whose members include HSBC Bank Plc (HSBA) and BNP Paribas SA (BNP), is looking to South Korea, Singapore and Australia to find allies in its efforts to persuade Basel to rewrite its liquidity rules.
The group wants global regulators to grant covered bonds the same status as government debt, giving banks limitless scope to use the securities in liquidity buffers.
“It’s a question of levelling the playing field,” Luca Bertalot, head of the Brussels-based ECBC, said in a phone interview. Covered bond issuers in Asia “have the same interests as we do.”
Since Basel unveiled its liquidity rules in 2010, Denmark has led criticism against the committee for treating covered bonds as second-class assets. Now, as the group of nations willing to challenge the framework grows, Basel faces a new fight from a lobby that’s showing little sign of giving up.
Under Basel rules, banks face a January deadline to build up stockpiles of assets that can easily be converted into cash. Lenders need to survive 30 days of limited or no access to funding. Basel requires banks to limit covered bond holdings to 40 per cent of their liquid assets, and to book the securities at 85 percent of their market value. It gives all government bonds, including debt sold by bailed out nations, such as Greece, the highest liquidity status.
Basel views its proposal as a “concession” to covered bond issuers, Wayne Byres, the committee’s secretary general, said by e-mail. “As a general principle, all bank-issued securities — deposits, bonds and equities — are ineligible” for inclusion in the top liquidity bracket, he said.
Basel acknowledges that some covered bonds — securities backed by collateral pools — are “less prone to illiquidity than other types of bank paper,” which is why the committee lets banks use them for 40 per cent of their buffers, Byres said.
Basel deems covered bonds inferior to government debt because “liquidity and credit risk are inextricable” as “assets covering the bonds are held by the issuing bank,” according to Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc.
Bail-In Exempt
“Covered bonds also reduce assets available to a resolving agency since — if they are high-quality enough to protect liquidity, they reduce recovery value of a closed bank,” she said in an e-mailed reply to questions. “It is for this reason that the U.S. for all intents and purposes has no covered bonds.”
Fritz Engelhard, managing director of fixed income strategy at Barclays Plc (BARC) in Frankfurt, argues that because European authorities “want covered bonds to be exempt from bail-ins,” that puts them “in a higher quality bucket compared to other bank debt.”
According toFlorian Hillenbrand, covered bond analyst at UniCredit Bank AG in Munich, “Basel is not the most appropriate body to understand covered bonds as most of its committee members are from countries where covered bonds play a small or non-existent role.”
The European Banking Authority, which comprises the region’s financial regulators, urged the European Commission in December to impose Basel’s liquidity rules across the region. For nations whose covered-bond supply dwarfs government debt issuance, the requirements pose a threat to financial stability, according to the Association of Danish Mortgage Banks.
New Landscape
In Denmark, banks use covered bonds to meet more than 70 percent of their liquidity needs. With public debt at 42 percent of gross domestic product — less than half the average in the euro area — the Association of Danish Mortgage Banks says there aren’t enough government bonds to comply with Basel.
The ECBC is now urging the European Commission to reject the recommendation. Europe’s executive arm is due to decide by June. Under EU plans for applying the liquidity coverage ratio, the rule will phase in so that banks will have to hold 60 percent of their required liquidity buffers from next year, and 100 percent by 2018, one year ahead of the international schedule.
Growing Issuance
“We’d like to reopen this debate at the Basel III level at the same time that we are lobbying at the European level,” Bertalot said. “At the time of the discussion of the Basel III framework, we were in a different landscape.”
The covered bond market reached 2.8 trillion euros ($3.9 trillion) at the end of 2012, almost doubling over nine years, according to the ECBC. The industry group holds its first meeting in Asia today and tomorrow, in Singapore.
Covered bond issuance from South Korea to Turkey has attracted some of the world’s biggest investors. Pacific Investment Management Co. opened the first actively managed exchange-traded fund linked to covered securities in January.
“A lot of countries have, or are, in the process of implementing a covered bond framework,” Bertalot said. “What was once a typical European asset class has become a global instrument and a vehicle for financing the real economy.”
Overturning Basel and the EBA’s proposal is Denmark’s “highest priority,” Danish Economy MinisterMargretheVestager said in a Feb. 25 interview. She’s been touring Europe to rally support and says Denmark, whose $550 billion mortgage-backed covered bond market is the world’s largest per capita, has won backing from Germany, France and Poland.
Denmark isn’t among the 27 nations represented on the Basel committee. Though some members, including the U.S., don’t have established markets for covered bonds, their growing popularity in South Korea, Singapore and Canada means other Basel members will lobby harder for their inclusion in the highest liquidity bracket, Bertalot said.
“It will be a tougher battle than in Europe, that’s for sure,” he said. “In Europe, we have 200 years of tradition and obviously covered bonds have achieved systemic importance in most of the countries. In other countries, we are simply at the dawn of the market.”
