Safety, transparency and liquidity – these are the three pillars of the covered bond industry. Like a financial Parthenon, the Pfandbrief market enjoys the grandest and oldest pillars of all, and provides the benchmark by which all other covered bond markets are measured.
Befitting its status as the world’s number one covered bond market, the Pfandbrief sector held up better than most markets, but everything has a breaking point. The first pillar, safety, was no problem: the Pfandbrief market has an illustrious tradition of 200 years or more without default. There has been no suggestion that this record was ever in jeopardy.
The second pillar, transparency, has been a hot topic in the covered bond markets this year. All crises lead to investor calls for increased transparency, and this one has been no different. Investors believe that greater insight into the composition of the collateral pools of covered bonds will enable them to make more informed investment decisions; and greater transparency in the secondary market will help protect that vulnerable third pillar – liquidity.
One of the greatest manifestations of the credit crisis has been the evaporation of liquidity – in all asset classes – and it was this problem that made the Pfandbrief structure so precarious, even if only temporarily. Where liquidity has been available, it has invariably been concentrated at the short end, presenting its own set of challenges to a diverse investor community, where many have long-dated liabilities.
But perhaps the biggest challenge to Pfandbriefe has been the solution to the problems being felt elsewhere in Germany’s financial markets – government-guaranteed bonds. The emergence of this super-safe debt security has caused something of an identity crisis for the asset that already saw itself as the ultimate risk-free asset. It has begged the question: if pension funds, central banks and insurance companies can buy government-guaranteed paper, why would they buy Pfandbriefe? That quickly leads to the next question: how long are these government guarantees going to be around?
No market ever stands still, and the events of the last year will invariably change the Pfandbrief market forever. On one level it needs to find a way to co-exist with government-guaranteed bonds, to boost liquidity and reinvigorate this proud old market. Yet there are other changes too: the investor base has started to change, and while issuers and analysts remain confident that its traditional investors will remain, the Pfandbrief market has started to attract a new breed of investor, such as hedge funds.
Some changes have nothing to do with the crisis, but reflect the spirit of innovation that has characterised recent years in the financial markets. Pfandbriefe comprised of ships or aircraft instead of real estate have started to emerge – an issue that has proved quite divisive in what is a conservative industry.
And, of course, Pfandbriefe have had to contend with the proliferation of covered bond markets around the world. While each new market flatters the original on which they are all ultimately based, each provides some level of competition – be it physical, in terms of luring investors away, or reputational, in terms of jeopardising the Triple A reputation the industry has amassed over the years.
The challenges are manifold. But the Pfandbrief market has overcome many such challenges before, and will live to do so again.
