An intragroup funding model included in the Commission’s Directive could be valuable for many issuers, according to a key user of such a method, but a joint funding model for separate entities may find fewer takers, bankers say, given competitiveness and legal hurdles.

On Monday, the European Commission unveiled a long awaited package comprising a Directive and associated Regulation that together seek to harmonise EU covered bond laws.

Among measures aimed at facilitating the growth of new and developing covered bond markets, the Directive proposes that member states may define rules on the use, by way of an intragroup transaction, of covered bonds issued by a credit institution belonging to a group as collateral for the external issue of covered bonds by another credit institution belonging to the same group, with some minimum requirements to ensure investor protection.

Morten Bækmand Nielsen, head of investor relations at Nykredit, told The CBR that the inclusion model in the Directive is a “formalisation” of the model Nykredit has been using for many years.

“We think this model works very well, it is prudent and it is safe, and we are very happy to see it included into the Directive and given a permanent stamp of approval,” he said.

“We think the model has served us well and it might come in handy for other issuers as well – a bank may have several issuers in the same group, and it can make sense to pool the issuance to create larger issues with better liquidity.”

Nykredit has since 2006 used a covered bond structure to transfer assets from one of its two mortgage credit institutions – Totalkredit – to its other – Nykredit Realkredit – with the latter used for market covered bond funding.

It has technically done so under a waiver allowing certain own-issued MBS and equivalents to comprise more than 10% of cover pools (dubbed the MBS waiver) that had in the past principally been for the benefit of French issuers, but who have since phased out the use of MBS in their cover pools. The European Commission made this temporary MBS waiver permanent in November, citing its use by Nykredit, on the understanding a new model in the Directive would replace it.

The Directive now proposes that the use of MBS will no longer be permitted in cover pools, noting that their use is only permitted under a few national frameworks and stating that their inclusion in cover pools makes covered bonds more opaque. Market participants agreed that the introduction of the intragroup model made the MBS waiver defunct.

The Directive states that the ability to pool covered bonds from different issuers as cover assets for intragroup funding purposes would facilitate the development of the issue of covered bonds, citing emerging markets in particular.

Joint funding model: will banks learn to share?

The proposed Directive also includes a joint funding model for separate legal entities, which would allow the use of loans collateralised by residential or commercial property mortgages granted by a credit institution as assets in the cover pool for the issue of covered bonds by another credit institution.

Bankers noted that the proposal gives limited detail on how the joint funding model must work in practice, except to state that member states must ensure investor protection by regulating the transfer of assets and ensuring that requirements on eligibility of assets and segregation of cover assets under Union law are followed.

Again, the Commission states in the Directive that permitting joint funding between several credit institutions would support the growth of covered bonds in member states where markets are not well developed, noting difficulties faced by small issuers in establishing covered bond programmes and issuing sufficient volumes for their bonds to be liquid.

Boudewijn Dierick, head of covered bond and ABS flow structuring at BNP Paribas, noted that such joint funding has rarely been implemented to date.

“We have seen a few of these initiatives in the Nordics – like Aktia and the Sparebanken alliance, and arguably you can say it is done by the Swiss Kantonalbanks – but it has mostly been done by banks that already work together under a similar brand anyway, not by completely independent banks,” he said.

Cooperation between independent institutions is more difficult, said Dierick.

“You will always see one bank that thinks ‘well, my book is better than yours and my risk is lower than yours, and I am better bank than you, so why should I share?’” he said “If you really want to get cheaper funding and diversify the risk for investors, that also means if one bank falls away, the other one takes over.”

Therefore, the proposed model is unlikely to be a game-changer, said Dierick.

“It will take time to see this – I don’t think that we will suddenly have lots of banks working together to issue together,” he said. “Costs may be too high compared to the upside in funding spreads.”

Bankers said that the joint funding model would allow for pooling of assets by credit institutions in different jurisdictions.

The ministries of finance of Latvia, Lithuania and Estonia are currently working on a pan-Baltic framework to facilitate such pooling of assets cross-border.

However, bankers noted that more hurdles would have to be overcome for such cross-border pooling to take place.

“It is a nice idea, but I’m not sure if the Directive would be the decisive factor in allowing that to happen,” said one. “I think the real impediment to cross-border issuance would be insolvency laws and laws on consumer protection.”

Dierick agreed, adding some investors may be hesitant to invest in such programmes.

“There are successful cross-border programmes, like in the example of Danske, but often investors say they prefer to allocate between countries themselves,” he said. “In the Baltics, for example, it may be different, because the banks are so small on standalone basis.

“But still, there is a lot of ‘buts’ and ‘ifs’ involved in combining the laws of separate countries.”