ATTEND A TYPICAL Copenhagen dinner party and conversation will invariably turn to the Danish covered bond market. It might seem a little offbeat, unless of course, you’re in the company of mortgage-bond bankers. In Denmark, though, this is a way of life. For the Danish covered bond market is the place where Danish homeowners meet to buy and sell their mortgage obligations. It is in effect the “people’s bond market”, created by and for the borrower, and it has been that way for more than 200 years. It now makes up 80% of Denmark’s fixed-income market. But now these traditional ways are under threat from the wave of regulation that naturally follows any financial crisis. The Basle Committee on Banking Supervision, in setting new capital requirements for bank liquidity buffers under Basle III, has placed limits on the amount of covered bonds banks can hold on their balance sheets as part of the liquidity coverage ratio (LCR). Moreover, they also stipulate that institutions should use government bonds to populate the liquidity buffer.
That’s a problem for Danish banks for two reasons. First because of their reliance on covered bonds as liquidity instruments, to the extent that they make up more than half of the investor base; secondly, because there isn’t a large enough stock of Danish government debt to replace the liquidity shortfall under the new rules.