The transposition of the covered bond directive into national law is happening at different speeds across Europe, with the CEE region lagging the leaders. Although understandable, this could be problematic.
It goes without saying that the Germans are in the vanguard. Pfandbrief are too important to Germany and the vdp too professional for it to be anything else. I don’t even need to resort to tired stereotypes about putting towels down before breakfast to reserve interpretations of key phrases.
They also recognise the importance of doing this more than most. Its easy to dismiss the covered bond directive (technically, also the covered bond regulation) as being quite easy to implement – ‘principles based’ just sounds like something that isn’t going to cause problems. The spirit of the directive was the spirit of compromise to avoid disruption to the already functioning, so can it really be so problematic?
It is understandable that some countries, particularly those in central and Eastern Europe, might not push implementation to the top of their ‘to do’ list. With implementation quite time consuming, and, to the extent that it will need legislation, political capital consuming, without a voice as loud as the vdp, and with covered bonds being a much smaller portion of total bank funding, it’s easy to see how implementation might slot into national ‘to do’ lists somewhere around implementing the EU light-bulb regulations and rearranging the sock drawer.
It would also be wrong.
I see three main reasons for this, the countries of central and eastern Europe have more to gain from the directive than others, they have more to lose from getting it wrong and they are more likely to get it wrong if they don’t act sooner rather than later.
Firstly, the gains. Five years ago when we started the whole process, one of the key premises was that differences in national credit spreads indicated a problem to be solved. Harmonisation of covered bond laws would reduce differentials – that was one of the thought, but unspoken, criticisms of the process from Germany, why would the country with the best funding conditions want compression of standards? This line of argument is of course irrelevant now that the ECB buys everything that moves and the gap between cheap and expensive covered bonds is negligible. One day that will end, spreads and differentials will widen. Will we see a return to the old relative value construct or lesser differentiation between the newly harmonised types of covered bond? Only when we know the answer to that will we know whether the starting premise of the directive was correct.
Secondly, the loses. Neutral though the directive is, some will face bigger implementation costs than others. Some of the costs, like the costs associated with all regulatory changes, are of a fixed nature and quite simply cheaper for a larger issuer amortising them over greater funding needs than for the smaller issuers in the CEE region. Other losers from the directive are countries with unpredictable asset amortisation profiles who have less natural hedging of their liquidity needs. The six month liquidity buffer requirement will always be more of a pain for countries with floating rate mortgages than for, well, Germany.
But the biggest potential loss is getting it wrong. Not in a way that a country will mess up their legislation and suddenly all covered bonds will be deemed non-compliant overnight. That won’t happen. Not in the CEE at least. But there are potential mistakes that can be made that will make it more expensive for issuers to conform to the new rules – I’m willing to bet that someone will get the rules on liquidity double count wrong, and others will wrongly implement the calculation of over-collateralisation.
Finally, the potential to get it wrong is far greater not because the directive is particularly complex, it isn’t, but because of the very light demands that the directive makes on the EBA. The securitisation directive – always a good compare and contrast exercise – has asked the EBA to interpret and develop multiple technical standards and this has enforced much more homogeneity on that market than the plethora of national discretions has on ours.
That should be a cause for concern.
At the Euromoney CEE forum in Vienna in January we will be discussing the implementation of the directive during the CEE Covered Bond Briefing 2020. Looking forward to discussing it with you there.
By Richard Kemmish