Germany’s umbrella banking industry body has called for the 180 day liquidity buffer to apply to the extended maturity date set to be introduced for Pfandbriefe, rather than the expected maturity, in a move the vdp says balances the security and efficiency of the product.

Sascha Kullig, vdp

The Ministry of Finance on 2 October published a draft bill aimed at transposing the EU covered bond directive into German legislation via changes to the Pfandbrief Act, with a consultation period running to last Thursday (29 October).

The Deutsche Kreditwirtschaft, comprising industry bodies representing five sectors of Germany’s banking industry, responded to the consultation on Thursday, with its submission led by the Association of German Pfandbrief Banks (vdp).

A key element of the draft bill is the introduction of maturity extension for Pfandbriefe, whereby they can be extended for up to 12 months, not at the behest of the issuer and only following the insolvency of a Pfandbrief bank.

Although the vdp has been working towards such a move for several years, the Deutsche Kreditwirtschaft is calling for the 180 day liquidity buffer – which is required by the directive and already part of the Pfandbrief Act – to be amended such that with respect to principal repayment it is calculated on the basis of the extended maturity date and not the expected maturity date.

This would align German legislation more closely with covered bond structures in other EU countries and, according to the industry body’s submission, prevent double coverage of liquidity risk relating to principal repayment.

Some market participants have highlighted that such a move – which would reduce costs for issuers – would make the extension of a Pfandbrief more likely.

“The undermining of the 180 day liquidity rule is certainly logical from the issuers’ point of view,” said Jörg Homey, DZ Bank analyst. “Moreover, securing payment obligations with a liquidity reserve and a maturity extension would be ‘double counting’ and unnecessary.

“At the same time, the erosion of liquidity requirements increases the likelihood of maturity extensions within the first 180 days after the insolvency of the Pfandbrief bank, which then is likely to trigger a cascade of subsequent maturity extensions of later maturing Pfandbriefe.”

Sascha Kullig, member of the management board, head of capital markets and investor relations, at the vdp, acknowledged that basing the 180 day rule on the extended maturity date could make an extension more likely, if a Pfandbrief bank became insolvent, but that under the current proposal, an extension for the first four weeks after the cover pool administrator is appointed might be opted for anyway – otherwise the vdp would not have argued for introducing maturity extension.

“Therefore, we think it’s not a big change to have this liquidity buffer based on the final maturity,” he said, “while still covering interest payments.”

DZ’s Homey said that while the move is “legitimate”, it does little to support the “international quality leadership” of the Pfandbrief Act when considered in conjunction with other changes put forward by Deutsche Kreditwirtschaft with the vdp that would rein in credit positive measures included in the draft bill.

Moody’s, for example, on 12 October noted that stricter eligibility criteria for financial institutions proposed by the Ministry of Finance are credit positive and go beyond what is required by the directive, but the vdp considers these too restrictive.

Kullig said that although overall “a very good one”, the ministry’s draft is “very conservative”, and in particular that liquidity risk does not need to be addressed by both maturity extension and the current 180 day rule.

“We asked for a less conservative approach in this respect, but for good reason,” he told The CBR.

“The vdp is known as an institution that wants to protect the Pfandbrief and make it as safe as possible,” added Kullig, “but at the same time, we want the Pfandbrief to be a product that can be used in an efficient way by our member banks. Therefore, it is important that the costs are not too high for them.

“If we were of the opinion that this change would damage the quality of the product, we probably wouldn’t have made this proposal. It is always a balance between security and efficiency. And it doesn’t make any sense to have a 100% safe product if it’s not being used anymore by anyone because it’s simply too expensive.”

Homey at DZ also noted that the vdp is pushing for changes to the bill in a few ways that would change credit quality for the positive, albeit less significantly. These include clearer working on maturity extension provisions, the modernisation of rules on building insurance, and strengthening the insolvency remoteness of cover assets.