Covered Bonds and the Need for Disclosure

The Financial Times published an article on covered bonds and the need for disclosure.  Since covered bonds are a structured finance product, the disclosure requirements should be exactly the same as for multi-tranche structured finance products.

As has been discussed many times on this blog, the useful, relevant information for a structured finance products, including covered bonds, includes the terms of the deal and the current performance of the underlying assets.  This asset-level data can be easily accessed from the issuer's loan database.

Covered bond experts have been called to Frankfurt to discuss the health of their market with the European Central Bank. 

The ECB bought €60bn of the bonds, an ultra-safe form of securitisation, during the financial crisis and has since taken a strong line on improving the transparency and investor-friendliness of the products. 

This parallels the ECB's efforts on ABS deals where the ECB has required that data on the underlying collateral performance be made available if the deals are to be eligible for being pledged to the ECB.

Banks have been selling covered bonds at a record pace, with nearly €120bn sold in the first quarter of this year, as investors plumped for the safest forms of bank debt. 

Unlike regular securitisations, which transfer packages of loans off lenders’ balance sheets – and which are still tainted by the “toxic” label of the subprime crisis – covered bonds are backed by loans that remain on bank books. 

The issuing bank also has to replace dud loans and the pool is ringfenced for the bondholders in a bankruptcy. 

... The ECB meeting, scheduled to take place on Friday, will focus on how to produce a system for labelling, or kitemarking, covered bonds to reassure investors about the quality of their holdings. 

It will also consider increasing the amount of information buyers are given about the assets that make up the underlying cover pool.

If the ECB would like, your humble blogger has an information system that would provide current information on the assets making up the underlying cover pool and would let market participants determine for themselves the quality of their holdings.

It is the second such “round table” discussion the central bank has held since it completed its buying programme last June and is intended to check up on the industry’s progress in meeting the ECB’s demands. 

... However, the calls for greater transparency are increasing tensions between investors and issuers as bondholders back policymakers’ calls for more data, but issuers push back against what they consider to be impractical proposals. 

“They’re asking for a Christmas list, frankly. They’ve cherry-picked the highest and toughest standards in the market without perhaps thinking about whether this can actually be done,” said one banker. 

As stated above, it can be done.

As other countries have adapted the German covered bond model to their own culture and legal systems, each market has developed slightly different habits and characteristics. 

“The problem is, some guys can produce the numbers with their eyes closed, but a lot of people just can’t provide this data,” the banker added. 

Actually, all of the issuers should be able to produce the data with their eyes closed.  It comes straight from their lending systems.

But supporters of the CBIC plans said the aim was to give issuers the space to explain their models, not to shoehorn lenders into providing numbers without considering whether they enhanced the information available.