In a research piece titled “Covered bonds at a turning point?” published by Scope Ratings the dominate role of the European Central Bank (ECB) for credit rating agencies becomes once more very obvious.
“The covered bond market is in upbeat mode. But while issuance has picked up significantly, public supply will remain well below the EUR 100bn mark of previous years”, says the report. The grim news for the relevance of the rating agencies for private investors lies in the following insight of Scope Ratings’ analysts: “Private investors remain sidelined as the market remains firmly in the grip of the ECB.”
The economies of scale of a rating agency come into full effect for investors when a large number of investors are confronted with a large number of issuers. In this case, the rating agency bundles analytical competencies in such a way that it makes the results of its research accessible through independent and easily understandable rating symbols. In a market full of investors and issuers, the rating agency acts as a true agent between these two sides of the market and helps to get to know each other better.
However, if the purchase of securities was mainly carried out by the central bank, it is crucial for the development of the rating agency to be recognized by the central bank. This is exactly where the problem is with all the rating agencies that are domiciled in Europe with their headquarters, because none of the European rating agencies has so far achieved the status of being recognized by the European Central Bank. Only the ratings of American agencies are relevant for the decisions of the European Central Bank.
Every rating agency operating in Europe must be registered or certified by the European Securities and Markets Authority (ESMA), according to the EU regulation on credit rating agencies. Only those who meet a large number of qualitative and quantitative requirements can afford an application for recognition. However, this effort does not guarantee recognition by the ECB.
But what are the factors behind the development of the covered bond market in Europe? “The key factor behind the increase has been the pickup of inflation,” said Karlo Fuchs, head of covered bonds at Scope. “Changes in the yield curve mean that positive-yielding covered bonds are again possible for tenors above seven to eight years. A year ago, investors had to buy long-dated maturities and significantly increase credit risk to get positive-yielding covered bonds.”
Fuchs notes that while EUR 28.3bn of new issuance since September is positive, it remains the tip of the iceberg. “As in previous years, publicly placed covered bonds will remain net negative this year so volumes need to be taken into the context of total market activity,” he said.
The ECB now holds more than 45% of covered bond benchmarks; more than EUR 710bn throughout all monetary operations. As such, changes to monetary policy can have significant repercussions on market activity. From a credit quality perspective, the most important impact will come from the orderly transition of retained covered bonds.
Asset and liabilty matching remains the most decisive factor for the risk profile and credit quality of covered bonds. We hope that the market’s largest investor is using its influence to encourage issuers to provide additional information on the share of retained covered bonds and the way and pace in which issuers are managing them to avoid a deterioration in programmes’ credit quality,” Fuchs said.
Although the term “covered bond” has established itself in the market and covered bonds are seen by investors as a separate asset class, the term conceals a large number of different securitisations. Therefore, the services of an independent rating agency are valuable to understand the differences between the instruments and, in particular, to recognize differences in creditworthiness. Covered bond harmonisation remains theoretical, as only five countries met the 8 July 2021 deadline.
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