An Association of German Pfandbrief Banks plan for its members to provide cover pool valuations incorporating haircuts for sub-investment grade public sector debt will incentivise issuers to reduce peripheral exposure, Moody’s said today (Monday), but the rating agency also cited shortcomings.

Under the voluntary initiative announced on Thursday, vdp members will, when reporting overcollateralisation levels, apply haircuts to public sector debt of sub-investment grade sovereigns depending on the probability of default implied by their ratings. Moody’s said that these will start at 11% for Ba1 and increase to 100% for sovereigns in default.

The rating agency said that the move will increase transparency.

“The initiative enables investors to compare deal-to-deal overcollateralisation on a risk-adjusted basis, according to the haircuts defined in the framework,” said Moody’s. “It thereby gives incentive to Pfandbrief issuers to further reduce peripheral risks embedded in Pfandbrief programmes.

“Investors in public sector Pfandbriefe will benefit the most from it: however, the new vdp standard increases the transparency of all types of German Pfandbrief programmes. Public sector debt can constitute both ordinary cover assets of public sector Pfandbriefe and substitute collateral of mortgage, ship and airplane debt Pfandbrief.”

Moody’s cited what it said are shortcomings of the initiative when saying that further improvements to the German framework are warranted. It said that the calculations will not take into account the duration of the sovereign credit risk or default correlation.

“Our asset model for public sector cover pools, however, does take those factors into account,” said the rating agency. “We model asset durations, default and recovery correlations and assess the credit risk of each obligor in public sector cover pools individually.”

Moody’s also noted the voluntary nature of the initiative.

“The third shortcoming is that the application of the new standard is not part of the legal framework and is not mandatory for Pfandbrief issuers,” it said. “Nevertheless, vdp member banks account for 99% of Pfandbrief issuance: consequently, the vast majority of Pfandbrief investors will benefit from the initiative.”