A Labour Party spokesperson said today (Tuesday) that a New Zealand covered bond bill posed questions similar to prostitution reform in the country and that, while the Opposition would support it for now, it had serious concerns about several aspects including a proposed 10% limit.

Opposition spokesperson David Cunliffe

In a debate upon the first reading of the Reserve Bank of New Zealand (Covered Bonds) Amendment Bill, David Cunliffe, Labour spokesperson for economic development and associate finance, said that the bill reminds him “rather a lot” of a Prostitution Reform bill passed in 2003.

“There is a practice in the marketplace that many New Zealanders feel uncomfortable about, in this case it is covered bonds,” he said. “A covered bond is a vehicle by which large wealthy institutional investors get themselves to the top of the security queue and mum and dad investors go to the bottom because they do not participate in the special purpose vehicle which extends the guarantee to the big investor. So this is a queue jumping mechanism.

“And like prostitution, the issue here is whether it is better because it exists to legalise it and regulate it, or to pretend it does not exist.”

Cunliffe said that there had been “quite an active debate” in the Labour caucus as to how to handle the bill, because, as a starting point “we are not enamoured of covered bonds”. However, he acknowledged that there are counter-arguments in favour of covered bonds, most of which Associate Minister for Finance Stephen Joyce of the governing National Party had described when opening the discussion.

Joyce said that the bill is an important part of government moves to improve the resilience of the New Zealand financial system to volatility in international markets, adding that it is essential that New Zealand banks have access to offshore markets on the same terms as others.

Joyce said that covered bonds would help the resilience of the country’s financial system in three ways: they provide access to a significant alternative investor base that tends to include longer term investors; issuance is typically longer term than in the senior unsecured market, where supply is shorter dated, with the associated risks that entails; and the covered bond market has been shown to remain open at times when others have not, including during the financial crisis.

Covered bonds will therefore reduce banks’ probability of default and support the economy by helping banks maintain lending when other markets are closed, he said.

Joyce then said that covered bonds could nevertheless increase unsecured creditors’ losses with covered bond holders ranking ahead of them, but said that a limit on the level of assets encumbered by covered bond issuance at 10% of total assets had been set by the Reserve Bank to minimise any potential impact on creditors and depositors.

“That balances the benefits of a lower probability of default with the need to minimise creditors’ losses should a default situation in fact occur,” said Joyce.

However, Labour’s Cunliffe questioned whether 10% is an appropriate level. He said that this was a level that the rating agencies considered appropriate, but noted that Australia has an 8% limit and that rating agencies’ interests might not be the same as the Crown’s.

Cunliffe said that while Labour would support the bill passing to its next stage, a select committee hearing, it would there be asking whether the limit should be lower than 10%.

“What’s wrong with 8?” he said. “What’s wrong with 7.5%? What’s wrong with 5%?”

He added that he wanted to ensure that regulatory oversight by the Reserve Bank would be sufficient.

“We don’t want the impression that we’ve cleaned up the Wild West but have a sheriff with no guns,” he said, “or a pop gun in the face of some of the largest, most powerful institutions in the country.”

Associate Minister Joyce had earlier said that said that while New Zealand banks had already been issuing covered bonds for two years, a legislative framework would improve banks’ access to the market and positively affect the rating of their covered bonds, lowering the cost of issuance.

Video of the debate can be watched here:

http://inthehouse.co.nz/node/12803

Joyce features in part 1, Cunliffe, in part 4