Few markets managed to come out of the crisis in one piece. But for covered bonds, the past few years have been different, with the asset class coming out bigger and more enhanced. Once considered a niche – even, some might argue, boring – product, the decline of other parts of the bond market have suddenly cast it into the limelight, bringing a variety of new participants into its orbit.
Nature abhors a vacuum. And when the illusion that sovereign debt – any sovereign debt – is risk free was shattered, investors were left with a very considerable gap in their portfolios. One strong contender was the market that has been around since 1769 and has never witnessed a default: covered bonds. That statistic might sound like risk-free to some, and it certainly sounded low risk to most others: investors had a new safe haven, creating a demand that has underpinned issuance ever since.
Sovereign debt is not the only market whose fortunes are closely intertwined with that of covered bonds. The asset class’ story cannot be told without some reference to the structured finance market, the decline of which has also offered a leg up to its rival – and the revival of which could potentially knock it back down.
Senior unsecured debt is a less anatomically obvious comparison, but is another market with some level of inverse correlation, even if it proves fleeting. Another titan of the low risk investing universe, senior unsecured debt has seen covered bonds make modest progress at its expense not because of a crisis of confidence but principally because of regulatory treatment.
There is no doubt regulators everywhere have been entranced by the covered bond market and this is reflected in the structures that are emerging in the post-crisis settlement. From the Basel Committee down to national regulators – in both established covered bond jurisdictions like Germany, and prospective centres like the US and Australia – incentives are being erected that look set to ensure the market’s growth continues apace.
And at the forefront of this is the European Central Bank, which singled the market out back in 2009 as the centre of its financial stability strategy, a market vital to the health of the real estate market and the system generally. The ECB’s €60bn purchase programme has been crucial to the performance of the market and the confidence in it that has followed, and while debate continues as to whether the programme achieved its objectives, there can be no doubt its explicit endorsement of covered bonds has helped convince many newcomers to look at the market for the first time.
The covered bond market has entered a new chapter of its long existence. With issuance up and rising, a host of new issuers and investors of every stripe now actively engaged, it is more visible than ever before. Practitioners are rightly proud of its long history without default. All will be hoping the added pressure that comes with these extra volumes does not jeopardise this record.
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