GFS LinkedIn
GFS Facebook
GFS Twitter
GFS RSS feed

Are covered bonds the future?

Wednesday 16 March 2011 - by Andrew Hickley

 The once unglamorous covered bond is again attracting the attention of investors, policymakers and regulators. Andrew Hickley speaks to the European Covered Bond Council to find out what the fuss is all about.

As asset-backed securities took a hammering in the financial crisis, the modest covered bond - the debt security backed by mortgages and public sector loans - has in turn seen its stock rise and rise.

Today the covered bond makes up some 24 per cent of the total European mortgage funding market and is likely to make further inroads after being included in proposed CRD IV liquidity rules.

Yet, despite its newfound popularity, Luca Bertalot, head of the European Covered Bond Council, argues that the asset's role as a security haven is under appreciated. By way of example, he notes that no covered bond has failed for 200 years.

Under the Basel III agreement's liquidity coverage ratio, which would be applied to bonds regardless of their maturity, a precautionary 15 per cent haircut is to be imposed on covered bonds. Banks would be forced to keep enough liquid assets to fund all outflows for the next 30 days.

Bertalot is riled by this. He argues that the haircut figure is unfair given past market history. "The level of haircuts for covered bonds in the LCR suggested under the Basel agreement is not supported by either evidence or market practice," he says.


"We call for a more appropriate level of haircuts, such as those used by central banks for repo operations."

Banks, he says, generally seek a balanced liquidity portfolio in terms of the duration of their maturities, and the haircut would discourage banks from using short-term bonds.

He adds that, in the event of a liquidity crisis, the higher interest to be attained from longer-term bonds would present difficulties.

"As experience from the current crisis shows, shorter maturities have always been in better trading conditions in times of stress.

"Hence, it is fair to state that banks tend to have better access to liquidity without having to approach the corresponding central bank if the duration on the assets held for liquidity purposes is on the lower end."

Bertalot points to the European Central Bank's covered bonds haircuts. The ECB classes AAA to A- fixed coupon jumbo-covered bonds as category II instruments for collateral, with haircuts of between 1 and 7.5 per cent, depending on the length of their maturity.


Article pages: |   1  |  2  |  3  |



WHAT DO YOU THINK?
 
Name:
   
Email:
   
Comment:
   
Post as Anonymous
  Display name
   
Please, enter security code
   
 

No comments yet.

STRAW POLL

Will markets in 2012 have a tougher time than 2011?

Yes

No

Don't know

View results

FIND A REGION world regions