The Canadian government is said to be considering preventing the inclusion of Canada Mortgage & Housing Corporation insured residential mortgages in cover pools when it introduces impending covered bond legislation.

A consultation paper released in May 2011 outlining the proposed legislative covered bonds framework in Canada asked: “Should the framework encourage the use of uninsured collateral and if so, how should it do so?”

It also noted that using uninsured mortgages as collateral can, in the longer term, reduce reliance on government-backed mortgage insurance and also improve the liquidity of uninsured mortgages.

Market participants said that they understand Canada’s department of finance to be considering the move. One said that the Canadian government is also reflecting more generally on the role of CMHC, not just in relation to covered bonds.

A syndicate official in New York said that such a move could potentially affect new supply from Canada, while discussing US dollar benchmarks for Bank of Nova Scotia on Friday and Bank of Montreal on Monday.

Six of the seven Canadian banks issuing covered bonds have cover pools that consist entirely of CMHC insured mortgages. The Covered Bond Report understands that were the new legislation to prohibit the use of such mortgages, there would be grandfathering for outstanding bonds featuring CMHC insured collateral.

Royal Bank of Canada is the only Canadian bank that has not relied upon CMHC collateral. According to a syndicate official, its covered bonds in US dollars tend to trade around 5bp wider than other Canadian issuers with CMHC collateral. However, being regarded as the strongest Canadian bank, RBC typically trades tighter than its peers on a senior unsecured basis, so the difference in value between the two types of collateral is likely to be higher.

Responding to an enquiry on the potential move from The Covered Bond Report, a department of finance official was non-committal.

“Canada released a consultation paper in May 2011 which laid out a number of proposals and questions for discussion, including asking if the legislative framework should encourage the use of uninsured collateral,” he said. “After receiving feedback on the consultation paper, the government will be coming forward with legislation on covered bonds in the near future.”