The Association of German Pfandbrief Banks (vdp) is working with dealers to implement a successor system to market-making aimed at revitalising the jumbo Pfandbrief in the eyes of investors and central banks.

Inter-dealer market making – which was a feature of the jumbo Pfandbrief market from its launch in 1995 and then the wider covered bond market – broke down in August 2007 after the onset of the financial crisis and never recovered. A last, unsuccessful attempt to restart market-making at the behest of the vdp came just weeks before the collapse of Lehman Brothers.

Jens Tolckmitt

“As we all know, market-making stopped after Lehman and since then the whole industry on a European level has been struggling to find a new standard and it turned out to be difficult to find a solution,” Jens Tolckmitt, vdp chief executive, told The Covered Bond Report. “So in Germany we decided to try to find a solution on a German level to get something going and create something that others may join later, if they think it is feasible.”

And he said that to his knowledge there have not been any initiatives in other countries to revitalise what was formerly called market-making.

“The reasons for the initiative are to restore the framework investors were promised when they bought a Jumbo Pfandbrief,” said Tolckmitt, “and to secure the special treatment afforded jumbo covered bonds by central banks in their liquidity operations.”

“We don’t want to be asked in order to develop something, but want to be pro-active.”

Tolckmitt said that there are two elements to the new project.

“The first is that we will have minimum standards as the basis for Jumbo Pfandbrief that will require price quotation of syndicate banks to Pfandbrief investors,” he said. “The difference between the old system and the one we want to introduce is that we will concentrate our efforts on prices for investors, instead of giving prices to the street, too.

“The second element is that we want to replace the fixed bid/offer spreads of the old system – which were too tight – with market transparency. This means showing spreads of different Jumbo Pfandbriefe on a daily basis to give investors a feeling for where the market is and whether a price is in line with overall market pricing.”

He said that this would be average prices quoted once a day.

“What we are currently testing is whether this system works,” said Tolckmitt. “We’ve really just started out on this and it will take a little time to be sure what works.”

The European Central Bank still differentiates between jumbo and other covered bonds in its collateral framework. However, ECB officials have raised concerns that the term “jumbo” is no longer meaningful and have at the same time been pushing for greater liquidity and transparency, with the Markets in Financial Instruments Directive (Mifid) also putting transparency on the agenda.

“We have known for a year that the EC intends to extend the post-trade transparency regime that you have already for equities under Mifid to the bond markets,” said Tolckmitt. “That agenda would have helped perfectly to move on with this.

“However, we didn’t want to have to wait the extra two to three years until it is implemented in national law, but to revitalise the former market-making now. Therefore our initiative is supposed to be a bridge closing the gap from now towards Mifid.”

The initiative could tie in with efforts to win better treatment of covered bonds when the Basel III framework is implemented in the European Union through CRD IV, with the liquidity of assets a key criterion for their position in liquidity buffers. However, Tolckmitt said that this was not a key driver behind the initiative.

“Ultimately, liquidity is an issue that is also addressed within the LCR eligibility criteria, but the initiative is actually for the reasons I have already mentioned,” he said.

The vdp has been working with the Association of Danish Mortgage Banks (Realkreditrådet) and associations in several other countries on a proposal under which certain covered bonds would be treated as Level 1 rather than Level 2 assets, contrary to the Basel Committee on Banking Supervision’s framework.

“We are proceeding with that initiative,” said Tolckmitt. “We are still working actively on it and continue to propose our criteria – but the discussion as far as I understand from Brussels is still quite open. Everybody accepts that something has to be done with regard to covered bonds.

“And as we have always said, the aim of the initiative is to make the case to European regulators and open up a discussion on this important topic,” he said. “If, finally, we end up with different criteria from those we specified which fulfil the same task, we are absolutely fine with that.”