The prospect of covered bond CDS has been met with scepticism by many market participants, who said that the concept clashed with the asset class’s fundamentals and that liquidity will likely be an issue – although an influx of credit investors could yet yield an audience.

An initiative to introduce standardised covered bond CDS is understood to be nearing fruition, with Credit Suisse, Deutsche Bank and JP Morgan said to be involved. (See here for more.)

Market participants surveyed by The Covered Bond Report noted an absence of concrete information about the initiative and end product, and expressed scepticism about the need for and viability of credit default swaps for covered bonds.

“Frankly, good luck,” said a syndicate banker.

A fund manager who focuses on covered bonds was unconvinced of the need for covered bond CDS, and said that CDS, in their initial purpose of providing protection against credit losses, contradict the concept of a covered bond per se because the asset class has such insurance built in.

A covered bond DCM banker echoed this.

“It goes fundamentally against what we’ve been selling as the covered bond asset class,” he said. “I could imagine that some of the Norwegian or German issuers would flip when they hear of this.

“But then again banks are always coming up with new ways of extracting money from investors.”

The fund manager noted the potential for the use of CDS to hedge mark-to-market risk, but questioned whether a dedicated covered bond version would offer much improvement on a “dirty hedge” via senior financial and sovereign CDS.

“I consider the additional gain in the sense of their possibly being an even better hedge to be very limited,” he said.

He also questioned whether there would be enough demand for the product to create meaningful liquidity in covered bond CDS, noting that real money investors are not interested in the product and that potential users of covered bond CDS, such as structured product desks that have gained exposure to covered bonds via collateral, constitute a small market segment.

“So far I’m missing the big convincing argument why there should be CDS for covered bonds,” he said.

The syndicate banker also focussed on liquidity as the key challenge for the product, and suggested that it would take more than three banks to achieve this, but that there may be limited appetite from others to get involved, with big bid-ask spreads a deterrent and the negative political perception of derivatives such as CDS also an issue.

A representative at a trade body referred back to a previous initiative from JP Morgan, and said that he “was not sad” that it did not lead to much. He was reluctant to comment on the likelihood of the latest initiative succeeding or otherwise, but noted that the covered bond investor base had changed.

“There are many more from a securitisation or credit background,” he said, “and are maybe more likely to have an affinity to CDS than the traditional investors.”