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144a or Reg S?

09 February 2018

I am looking forward to hearing the special debate on Reg S Vs 144a issuance at the forthcoming Vancouver covered bond conference. I just wish that fully SEC registered bonds were still on the table.

When you arrive in Vancouver for the Euromoney North America Covered Bond forum next April, one of the first things that you’ll see as you leave the airport will be a sign to the US border. It’s about a 30 minute drive. Sadly, the distance between the Canadian covered bond issuers and the American investors is a lot wider.

My simplistic way of thinking about the options open to non-US issuers who want to raise dollars is that it is a continuum: one end involves a vast investor base, liquidity, cheaper funding and enormous disclosure and legal costs, the other is easy and off-shore. 144A falls somewhere inbetween the extremes both in terms of investors – some, not all – disclosure and legal bills.

Assuming we all want a market without barriers the trend is going the wrong way for two reasons.

Firstly, an issuer thinking purely in terms of costs will balance the basis point saving of accessing all of those American investors with the greater upfront costs – both legal and IT related. With the demand for covered bonds globally so much stronger than supply, the spread compression that has been a defining feature of the market for the last three years isn’t just compression between issuers or countries but also between issuance formats – the spread demanded by investors in fully registered bonds, 144a bonds and Reg S bonds is inevitably far narrower. So upfront costs are so much more difficult to justify.

Secondly disclosure standards are ever more onerous. This applies to issuer disclosure – probably nothing you can’t get over – and to pool disclosure – the latest SEC rules demand 270 data fields for every single mortgage in the cover pool. 270. I’ve been working with mortgage pools for many years and I’ve absolutely no idea how they managed to come up with a list of data items so long.

If the ‘how’ is difficult, the ‘why’ at least is easy. Without a tradition of covered bonds in the US the obvious precedent for their regulatory disclosure standard is the securitization market. The many reasons why disclosure should differ between the two instruments – recourse, revolving pools, track record, - are irrelevant. Nobody at the SEC is going to put in place a different data template for such a small asset class.

The over-protective disclosure standards are of course counter-productive. By saving investors from a lack of (irrelevant) cover pool data the SEC is stopping many of them investing in any covered bonds and forcing them to old, mainly US, securitization bonds instead. A concentration of risks that can hardly be argued to enhance systemic stability.
For others – the qualified institutional investors who are at least able to buy 144a bonds – the SEC rules are depriving the market of the small ticket investors who would provide secondary market liquidity. Again, not helpful.

There is a lot of talk about Basle rules being modified to globally standardise the prudential treatment of covered bonds. This is a laudable objective – it will encourage geographic diversification of investment portfolios and accurately align risk and prudential treatment. But as long as the SEC makes it hopelessly inefficient for non-American issuers to sell covered bonds to the vast majority of US investors the prudential treatment is more or less irrelevant.

By Richard Kemmish


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