Covered Bond Shock Forces Denmark to Examine ‘Plan B’ for Banks

Covered Bond Shock Forces Denmark to Examine ‘Plan B’ for Banks

Denmark is mapping out a new battle plan to protect $555 billion in mortgage bonds after Europe’s bank regulator proposed rules that threaten to trigger a sell-off of the securities.As Denmark urges the European Commission to ignore a plan by the European Banking Authority that covered bonds be treated as second-class liquid assets, the mortgage industry is focusing on a clause that offers special treatment to nations with low government debt levels.

“This is Plan B,” Morten Frederiksen, head of regulatory affairs at the Danish Bankers Association in Copenhagen, said in a phone interview. Ensuring the EU Commission ignores the EBA’s proposal outright is “our main focus. But of course, if the decision doesn’t go our way, we have to look at alternatives.”

Denmark’s mortgage industry was blindsided in November, when it emerged the London-based EBA would ignore the findings of its own technical study, which showed covered bonds are as liquid as government debt.

The EBA wants Europe’s banks to limit holdings of covered bonds to 40 percent of their liquid assets, and to book them at only 85 percent of their market value, echoing 2010 rules set by the Basel Committee on Banking Supervision. Government bonds across Europe, whether Greek or Italian, should carry the highest liquidity status, according to the EBA.

Liquidity Buffers

Danish banks hold about 34 percent of the mortgage market, the world’s largest per capita. The securities make up as much as 75 percent of banks’ liquidity buffers, industry estimates show.

Frederiksen says Denmark will focus on a clause in the EBA’s Dec. 20 recommendation on covered bonds, which opens the door to letting nations with a shortage of government securities exceed the 40 percent cap.

“We have to be ready with alternatives,” Karsten Beltoft, director of the Danish Mortgage Bankers’ Federation that counts Danske Bank A/S (DANSKE)’s mortgage arm among its members, said by phone. “We have to discuss what to do if it doesn’t go the way we want, what the options are.”

Denmark’s covered bond market is almost four times the size of its stable AAA-rated government debt market, and more than 1 1/2 times the nation’s $340 billion gross domestic product, central bank figures show. Denmark’s public debt will reach 43.7 percent of GDP this year, compared with a euro-zone average of 95.9 percent, the EU Commission said Nov. 5.

Currency Option

According to the Association of Danish Mortgage Banks, whose member banks include Nykredit Realkredit A/S, there aren’t enough government bonds in Denmark to fulfill banks’ liquidity needs.

Forcing banks to limit mortgage bond holdings to 40 percent of their liquid assets “will destroy the Danish financial architecture,” Ane Arnth Jensen, the association’s director, said in an interview. She’s adamant that the bonds deserve the highest liquidity status and says Denmark shouldn’t have to compromise.

The EBA also has proposed that banks in Denmark and Norway, which both have have krone-denominated covered bond markets that dwarf their government debt markets, be allowed to hold assets in foreign currencies to help soften the blow.

The EBA also suggests the two countries set up dedicated central bank liquidity lines to meet banks’ requirements. That could present a policy challenge for the Danish central bank, whose sole mandate is to defend the krone’s peg to the euro. Forcing banks to hold some of their liquid assets in foreign currencies may also introduce new risks, Frederiksen said.

Not Alone

“We prefer not to have the currency risk of buying euro-denominated assets,” he said.

Economy Minister Margrethe Vestager said last month the government will fight to ensure the EBA is sidestepped, while Denmark’s financial watchdog told banks to disregard the EBA for now. Central bank GovernorLars Rohde predicted the European Commission will pay greater attention to studies showing covered bonds are as liquid as sovereign debt than to the EBA.

Denmark isn’t alone in lobbying the commission, which is due to make its decision in June. The mortgage bond industries of Norway and Germany, the European Covered Bond Council and the Covered Bond Investor Council have all aligned themselves with the Nordic country.

Denmark needs to fight for a higher cap, and “the higher the limit, the better,” Beltoft said.

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net