The introduction of lower risk weights for covered bonds in Basel reforms is a step towards a level global playing field for covered bond issuers, according to officials at DBS and CIBC, and will support the development of new markets and a broader investor base for the product.

On Thursday of last week, the Basel Committee’s oversight body, the Group of Central Bank Governors & Heads of Supervision (GHOS), signed off on outstanding Basel III post-crisis regulatory reforms.

The update includes new risk weights for exposures to covered bonds that are in line with those for covered bonds in the EU under the CRR, and represent the strongest recognition yet of covered bonds by the global regulatory body. The long-awaited reforms, which have been dubbed “Basel IV”, will be phased in from 2022.

The result was described as a major win for the covered bond industry, and in particular for covered bond markets outside the EU/EEA – though market participants are still cautious, and stress that much still depends on how the rules are implemented.

Colin Chen, managing director and head of structured debt solutions at Singapore’s DBS Bank and chairman of the ECBC’s global issues working group, told The CBR that the new regulatory recognition accorded to the covered bond asset class “sets the stage for a global harmonisation of global covered bonds”.

“This should result in developing a broad-based investor community, which further enhances the attributes of the asset class,” he said.

According to Chen, depending on how national regulators incorporate the risk weights into their respective regulations, the new recommended risk weights are likely to encourage investors to further diversify into the covered bonds of non-EU issuers.

“For new jurisdictions, such as Singapore, the new recommendations are likely to encourage interest from a wider set of investors as well as incentivising current investors to diversify into non-EU-issued covered bonds,” he said. “These new recommendations level the field for issuers and investors across jurisdictions.

For jurisdictions that do not yet have functioning covered bond markets but are working to establish them, the new rules further increase the asset class’s value, added Chen.

“The covered bond market provides institutions access to a deep and stable source of funding,” he said. “With these new recommendations, it expands the reach of their respective issuances.”

Chen said the importance of the Covered Bond Label moving forward has become all the more apparent, “as the only platform which banks can use to demonstrate to the global markets their compliance to the recommendations of the new Basel recommendations, and in the interests of transparency, in accordance to developing a qualitative framework globally for both investors and issuers.”

Wojtek Niebrzydowski, vice president, treasury, Canadian Imperial Bank of Commerce, said the new risk weights are “a step in the right direction in creating a level playing field globally for covered bond issuers”. He noted that it is also consistent with the direction of the EBA harmonisation initiative, although the details of the latter are still to be finalised.

However, while “a very welcome development”, Niebrzydowski said the decision on its own it is not sufficient to create a fully consistent treatment for global issuers.

“Given the anticipated implementation is five years from now in 2022, it’s not certain that the new risk weights will have any substantive impact on the issuers in the near term,” he said. “It should also be noted that Basel risk weights are constraints on banks’ balance sheet holdings of covered bonds and arguably not so for real money, official institutions or corporate investors.

“If nothing else at this time, the development should have a positive view on mid-term planning with regard to the potential and importance of covered bonds in the choice of funding programmes.”

Moody’s said the lower risk weights are credit positive for issuing banks’ sales of covered bonds outside the EU. It said currently active EU covered bond issuers will benefit because their covered bonds become a more attractive investment for non-EU bank investors.

“Amid rising minimum requirements for regulatory capital, risk weights applied in the calculation of banks’ stock of risk-weighted assets have gained importance in their investment decisions,” it said. “European covered bond issuers can diversify their investor base and potentially reduce their funding costs as demand for their bonds increases.

“However, some issuers may be incentivised to increase their share of covered bond issuance in foreign currencies,” Moody’s added, “thereby increasing their exposure to foreign-currency fluctuations given that cover pool assets typically are denominated in euros or other local European currencies.”

Outside the EU, lower risk weights will support the development of covered bond markets and encourage the product’s use, according to the rating agency.

“The additional funding source will make non-EU banks less reliant on deposits and the sometimes volatile unsecured wholesale funding market,” it said. “Additionally, the covered bonds will provide an opportunity to improve their asset-liability matching, particularly for mortgages, which typically have 20-30-year maturities, versus five to 10 years for covered bonds.

“In the EU, banks investing to fulfil liquidity coverage requirements, for example, typically absorb about one-third of primary covered bond market issuance.”

Moody’s expects that once the Basel IV rules come into force, non-EU banks will become more active investors in their domestic covered bond markets, thereby facilitating domestic mortgage funding.

However, a treasury official at another non-EU/EEA issuer noted that a key area of regulation in at least one major market will remain unmoved by the Basel moves.

“It’s irrelevant to US banks due to unfavourable LCR treatment,” he said.