Covered bonds: After 200 years, it’s come to this
So much so that many observers are now suggesting that other covered bond markets need their own equivalents. “The VDP is a great organization from a knowledge perspective,” says Bernd Volk, covered bond analyst at Deutsche Bank. “Any legal questions can be put to the VDP or the German regulator, rather than going to issuers. Given the legal details and opinions provided by the VDP and the fact that every country has a different legal framework, it would be very helpful to have that in other markets as well.”
When the UK government bailed out mortgage bank Bradford & Bingley in September, it initially failed to state that it would safeguard the bank’s covered bonds, unaware of the effect that such an announcement would have. After much confusion and hurried calls from covered bond bankers, the government reversed its position, saying it would guarantee the covered bonds.
Similarly, the covered bond issues of Dexia were not included in the Belgian/French government bail-out. Unlike in the Bradford & Bingley case, however, the covered bonds have not subsequently been included in the bail-out, and it is possible that Dexia’s unsecured debt could start trading inside its secured issues, a very uncomfortable situation for covered bond investors. In Germany, by contrast, there was no uproar about the exclusion of the Pfandbrief in the government guarantee package because the VDP was able to lobby for its inclusion. It is not a stretch to imagine that much confusion surrounding the UK and Belgian banks’ covered bonds could have been avoided had there been associations in these markets with the knowledge and political clout to ensure that covered bonds were included in any rescue package.
The Pfandbrief market is large. The 34 members of the VDP account for 95% of outstanding Pfandbriefe, with a value of €890 billion. Obviously such a sizeable market benefits from an independent body such as the VDP. In other covered bond markets, where there are perhaps only a handful of issuers, the concept of an independent covered bond association was never seen as necessary. The European Covered Bond Council was seen as adequate for all European markets.
But with the credit crunch, the dream of a homogeneous covered bond market was extinguished. Governments ceased to consider other markets when making policy decisions. Suddenly every representative in the ECBC was pulling in a different direction. "There are already banking associations in other markets but they’re not vocal for covered bonds," says Steffen Dahmer, head of covered bond trading and syndicate at JPMorgan. "The ECBC is good but every country has its own agenda."
Already, enquiries have been made. The most likely market to replicate the VDP is France, one of the oldest covered bond markets outside Germany. The US Treasury’s covered bond initiative also includes some form of independent body along the lines of the VDP but no details are known. But the rumblings are beginning to reach the right ears. "We’ve heard from one or two who have contacted us and asked us how to do it," says VDP executive director Louis Hagen. "But we’ve not heard of any concrete plans to do so yet."
Hagen says that he would welcome VDP-style organizations in other markets. It will take time to establish them but starting the process now might well make a homogenized global covered bond market far more achievable.