You might think that it’s a pity that the first major covered bond conference since the publication of the first ever draft of a covered bond directive is taking place outside Europe.
We don’t want to be rude to our Canadian hosts (covered bond people, like Canadians, are famously polite) or to all of the other non-Europeans who will be in attendance by going on about our parochial European concerns. But the good news – that might get lost in the noise – is that the first ever covered bond directive is of very direct relevance to Canada, Australia, Singapore and to covered bond markets yet unborn. Here’s why.
At the heart of the covered bond market for the last 15 years has been a tension between the need to harmonise and the need to respect national specificities. Harmonisation has obvious benefits, in particular in a market designed to facilitate cross border flows. I will buy foreign bonds if I know that the protection they afford is roughly the same as my domestic bonds. This was the story of the covered bond market in the early 90s when Pfandbrief were adapted to international norms (I suddenly felt very old writing that), it was the story in 2003 when we launched the first contract law based covered bond copying German market conventions, and in many other cases besides.
But covered bonds are local things. Mortgages are definitively local. So are the laws, regulations and credits that underpin them.
I believe that European Commission is correct. The tension between harmonisation and local concerns is best resolved by guiding principles for the market rather than detailed rules telling people how to value a mortgage. Some people in the market are sceptical about that idea, arguing that the draft directive lacks substance. They say that successful covered bond models should be forced onto new countries - harmonisation should take priority over specificity. I beg to differ.
If there is one, big overarching reason that the globalisation of the covered bond market has been slower than we would all have liked it is because of a lack of those guiding principles.
From my own experience, time and time again I have sat in meetings in countries without covered bonds where the regulator has fixated on copying details of markets very different from their own and totally ignored the broad principles that defined those markets in the first place.
Principles make it easy. When the EBA published their ‘Best Practice Principles’, for covered bond markets it had no power of law, but it was a gift for those of us trying to help new jurisdictions develop. I’ve had a lot of very fruitful conversations that started with: “According to the EBA, this is the objective that we are trying to achieve. Now how can we do that in your country?”.
The new Directive sets those broad best practice principles in stone without telling you how to do it in your country. It also, and this is where it really stops being of parochial interest, offers the promise that one day non-EEA jurisdictions might be eligible for prudential treatment for European investors. Only if they conform to those principles, of course.
A European Union directive isn’t a parochial concern at all. It could just be the starting gun for a global market.