Dr Nathalie Aubry-Stacey, advisor on regulatory policy at the International Capital Market Association (ICMA), discusses the European covered bond market and the changes it is undergoing to try and improve transparency

As part of the process embedded in the Market in Financial Instruments Directive (MiFID) Review, the Committee of European Securities Regulators (CESR) is to provide the European Commission (EC) with its technical advice at the end of July 2010. The Commission can now report to the European Parliament on possible changes to MiFID in early 2011. In particular, CESR, whose full proposals were still under wraps as FST went to press, is expected to elaborate on the non-equity markets transparency regime published in July last year. The consultation paper, revealed in May, considered the introduction of post-trade price reporting in corporate bond markets including for covered bonds.

Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. It is natural to consider covered bonds to be corporate bonds for transparency purposes as they are in the first instance a claim on the issuer and the ‘cover’ only comes in case of failure to pay - unlike a structured finance product where payment typically depends directly on the performance of the asset pool (with no claim on the issuer for any shortfall). Covered bonds are, therefore, relatively unique: an investor has recourse to the issuing bank, but if a bank is insolvent payments should continue to be made on the bond through to maturity from the collateral pool securing the bond. In many jurisdictions in Europe covered bonds are considered to be retail products rather than wholesale products.

From an investor’s point of view, post-trade transparency – the availability of price and trade information after a trade has been done – is seen as a positive step for the covered bond market. Efficient post-trade transparency should lead to more accurate information about pricing so benefiting investors’ achieving and controlling best execution. However, the mechanics behind a post-trade transparency regime need to balance transparency with liquidity. The crisis has highlighted that in an illiquid market, information is hidden. There needs to be a long-term view on this issue and there is no easy solution. Attempts to reintroduce the old market maker commitment for jumbo covered bonds, albeit in a much weaker form, have so far not succeeded. Banks for obvious reasons do not have the same balance sheet commitment as before the crisis and it is very unlikely that this will change.

More access to prices is a possible way to ensure fair pricing and tighter spreads as a result. One of the main challenges for the future is to expand the investor base for the covered bond product in a relatively fragmented European market, where no common definition is agreed upon. Post trade transparency is a part of the work that needs to be done as regards the transparency of the covered bond market.

The ICMA Covered Bond Investors Council (CBIC) has considered the use of a centralised electronic trading and reporting platform in this context and CBIC members have discussed the requirements for the functionality of possible platforms to ensure agreement from the investors’ side.

The three commercial platforms that have so far been presented to the Council and discussed by Council members were of different types for finding prices: a live executing model, a request for quote model and an auction system. The key factor in these discussions was the type of information required by investors, in terms of volumes and prices, and how easily available the information was to analyse.

The discussion about an electronic platform is one part of a more comprehensive on-going discussion about the restoration of the covered bond market. Investors are also calling for more transparency as regards covered bond programmes. Web tools provide today a certain amount of information about cover pool data, covered bond structures and legal frameworks. The European Covered Bond Council (ECBC), which represents covered bond issuers, has put in place a Covered Bond Comparative Framework Database that can be accessed on its website and highlights the essential features of different covered bond legal frameworks across Europe. I am sure this will go some way to improving transparency and look forward to further changes.

• For more information on the ICMA, its Covered Bond Investors Council, and other activities please visit: www.icmagroup.org.

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