Pfandbrief

Roundtable Pfandbrief 2019

August 2019

Roundtable participants (left to right above):

Neil Day, Editor, Covered Bond Report
Felix Rieger, Hauptgruppenleiter Management Euro-Portfolios, Fremdportfolios, Deutsche Bundesbank
Felix Zillmann, Treasury, BerlinHyp
Matthias Melms, Senior Director Head of Covered Bond and SSA Research, NordLB
Thomas Ludwig, Director, Debt Capital Markets Bonds Banks, Commerzbank AG
Götz Michl, Head of Funding and Debt Investor Relations, Deutsche Pfandbriefbank AG
Jens Tolckmitt, Chief Executive Officer, Association of German Pfandbriefbanks

Neil Day

Neil Day

The Covered Bond Report

What is it about the Pfandbrief that has resulted in it being such a long-lasting and successful product?

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

The stability and the high quality of the legal framework have been decisive in making the Pfandbrief such a long-lasting product. What is especially important today, is that it has over time consistently combined the spirit of tradition with the spirit of innovation to keep the product relevant. When trying to develop the Pfandbrief into new areas, we – meaning the Pfandbrief issuers – are mindful of the well-established principles that make the product safe, but at the same time are not bound by tradition. Look at the jumbo Pfandbrief. Look at green Pfandbriefe. Over time, they have given it a new flavour and made the Pfandbrief fit for purpose. And this is how we should continue. Most important for issuers is that in the face of all the regulatory developments the industry is confronted with, the Pfandbrief must remain a product that is economically viable for issuers to use. So whenever there are discussions about tightening the regulatory framework, it is important to ensure that the Pfandbrief remains competitive versus other products.

Felix Rieger

Felix Rieger

Deutsche Bundesbank

I am here representing the Bundesbank as an investor today – not for its role regarding monetary policy – and in this respect, investing money on behalf of Federal government entities, the Bundesbank is a very conservative investor. And it’s really the combination of the Pfandbrief being a very low risk product but at the same time offering a little bit more yield pick-up than a traditional government investment that is behind its success. But I think that after 250 years its reputation doesn’t really need to be explained anymore.

Looking at it from a broader perspective, the Pfandbrief is also very important for the economy as a whole in its function of facilitating real estate finance, whereby illiquid mortgages are transferred to liquid bonds – liquid not only in the market, but also in central bank monetary policy operations. Therefore, covered bonds are for us an asset class that we view very positively.

Matthias Melms

Matthias Melms

NORD/LB

Independently of the issuers and the assets that are behind the Pfandbrief, when we talk about 250 years of a success story we have to talk about the Pfandbrief law. A foreign investor once told me: I want to invest in Germany, in the German Pfandbrief, but I don’t care about the issuer, I don’t care about the assets, I just want to have the Pfandbrief with the highest spread. I asked them what the strategy behind that was, and they said: I think the German Pfandbrief law is the best law in the world and I’m convinced that there will never be a default of a German Pfandbrief. This best demonstrates how we have a special success story here in the German Pfandbrief law, which perhaps has the reputation of being the best covered bond law in the world. Indeed, we have seen several jurisdictions simply copy the German Pfandbrief law, or at least elements that were introduced like 180 days liquidity line. So the German Pfandbrief law in particular is a success story, not just the Pfandbrief, per se.

Thomas Ludwig

Thomas Ludwig

Commerzbank AG

The Pfandbrief has been alive for 250 years now, but it has changed and has developed. The way that issuers, lawyers and the market in general have combined to keep the instrument up to date has been key to keeping it in such a strong position.
Look at Helaba issuing a successful five year Pfandbrief with a negative yield – only by having a very deep investor base can you ensure such tight pricing, and the German Pfandbrief is still the tightest product in the European covered bond world. That makes the issuer’s life efficient, still having such a cheap instrument to refinance real estate as well as public sector lending. So yes, it’s a real success story.

Götz Michl

Götz Michl

Deutsche Pfandbriefbank AG

We grew up with the word Pfandbrief. Thirty years ago, the Germans were familiar with Pfandbriefe and Kommunalobligationen (the old name for Öffentliche Pfandbriefe), even if they were not working in banking. But times have changed. Other products are more familiar to retail investors – they invest in term deposits, maybe know about ETFs. Because of the low interest rate environment, the Pfandbrief meanwhile moved away from the broad investor base among retail investors to now being more focused on banks, asset managers and professional investors. That development is typical of the long history of the Pfandbrief, where we have seen changing trends in the product.

Felix Zillmann

Felix Zillmann

Berlin Hyp

We turned 150 years old last year, and the Pfandbrief has always been the most important refinancing instrument for us ever since. A lot of things have changed over that time, but the mortgage Pfandbrief and the business case for it remain the same for Berlin Hyp. This really proves the quality and the stability of the product.

Felix Rieger

Felix Rieger

Deutsche Bundesbank

What I have always found very nice is that compared to other asset classes, you have an instrument that is relatively simple, clear and transparent. Especially if you compare it with other kinds of securitisation, where you sometimes have 500 pages of documentation. With the Pfandbrief you have quite a small booklet, in fact, the Pfandbriefgesetz, and that’s basically all you have to know.

Neil Day

Neil Day

The Covered Bond Report

The European Commission has finalised a new “booklet” for European covered bonds in the form of the legislative package. How satisfactory is the outcome?

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

There are two key takeaways from the harmonisation package. Firstly, it is high quality, which is a very good development. This is a pre-requisite for safeguarding the preferential treatment that all covered bonds enjoy and which is important for the success of the product. Special preferential treatment is a key attraction to bank, insurance and fund investors, to name a few.

Secondly, it is a principles-based directive, so we maintain the ability to innovate and develop the Pfandbrief law further, which – as I said before – is one of the key elements in the success of the Pfandbrief. Importantly, it also maintains the competition, so to speak, between the different covered bond laws, so that people can go in different directions, and everybody can learn from the best.

You have to recall where we came from. We have discussed this issue for more than five years, and in the beginning full harmonisation was floated, as well as a so-called 29th regime. Compare that to where we have ended up, with a principles-based directive that, I have to say, has our full support.

Now that we are entering the implementation phase, it is very important the European Commission ensures that the leeway granted by this principles-based directive can be exercised in each and every country as each and every country wants to exercise it, and does not try to harmonise things via any other European institution. Making sure this really happens will be the key issue for the industry for the coming years.

Regarding the content, one of the most important issues is how to deal with the new covered bonds allowed on the second level, the directive level. Will they exist in all jurisdictions? What will they look like? And which assets will they be able to refinance? There are areas in which covered bond-like instruments or products using covered bond techniques could be used, but the extent to which it is permitted needs to be considered very carefully – in Germany, but in other countries, too – so as not to hamper the quality perception of the overall product.

Neil Day

Neil Day

The Covered Bond Report

Ensuring the privileged treatment by having minimum standards was part of the thinking behind the directive. Another aspect the Commission talked about in respect of harmonisation was making things easier for investors. Are you satisfied with the outcome of the directive?

Felix Rieger

Felix Rieger

Deutsche Bundesbank

In general, it is a very good outcome. There was definitely the need for some kind of harmonisation in Europe. The Pfandbrief is a very good product, but as an investor you want to have a broader scope, and until now when you moved across Europe you could become a bit lost, so to speak, with all the different jurisdictions. At the same time, nothing should be lost that is worth keeping, and this has been achieved – at the price, maybe, that a lot of differences will probably remain.

I hope that in the end the range of different kinds of covered bonds will not become too large as this will obviously reduce a little the transparency and level of harmonisation that was achieved.

Matthias Melms

Matthias Melms

NORD/LB

The Pfandbrief was the seed of the covered bond market 250 years ago, but since then covered bonds have grown into a global product. At least within the EU – where most of the issuers and investors are based – it was therefore necessary to have harmonised regulation. And although we have a principles-based approach, there are some elements that will be aligned across all EU jurisdictions. And I have to say that investors – especially second and third tier German investors who invest in Pfandbriefe and covered bonds more than anywhere else – find it helpful to be able to rely on such minimum standards, if they don’t have the capacity to analyse every covered bond law and every cover pool. That is the real value of the directive, to build trust in this product, at least in respect of the EU. And I’m pretty convinced that jurisdictions outside the EU will in future take the EU directive as a blueprint and try to be compliant with it, implementing some of the elements into their domestic covered bond laws.

Götz Michl

Götz Michl

Deutsche Pfandbriefbank AG

It is obvious that minimum standards will make it easier for a smaller investor in Germany to buy non-German covered bonds. From a European perspective, this is positive. Speaking as a German issuer, we benefit from a deep investor base in Germany buying the Pfandbrief. Some of these investors may now be motivated to buy other covered bonds, which is not to our advantage.

But even with some harmonisation, there will still be different issuers, different cover pools, different underwriting standards. So the question really is whether minimum standards are sufficient to attract further investors who understand the risk or whether it just creates a feeling of safety.

Matthias Melms

Matthias Melms

NORD/LB

It is not harmonisation with the Pfandbrief – with every jurisdiction having the same high standards as in Germany, with not only the Pfandbrief law but also the secondary legislation – but minimum standards that can be relied on. However, that is at least much more than we had in the past and a step in the right direction. And I’m pretty convinced that we have a better outcome than might have been expected – especially thanks to the various banking organisations, including the vdp, who influenced the debate around the directive.

Felix Zillmann

Felix Zillmann

Berlin Hyp

A potential benefit on a medium term perspective is that you achieve a global brand, which could lead other investors into the European market.

From a Pfandbrief perspective, [vdp president] Mr Hagen once said that the Pfandbrief is now part of a big orchestra, and this is really important when you look at the regulatory privileges the Pfandbrief has on a global level, namely LCR or RWA requirements. The directive makes sure this is still being granted and hence secures demand for the Pfandbrief.

Thomas Ludwig

Thomas Ludwig

Commerzbank AG

Overall, this kind of minimum standard indeed makes the investor’s life easier. And if in terms of credit quality and pricing you are one of the strongest parts of the asset class, maybe you will lose a little differentiation from the weaker ones. But in general all participants can benefit from a broader investor base. If you look at the order books for German Pfandbriefe over the past several years, for example, we have learned that the investor base is not static, it very much depends on relative value. Having a broader investor base with different regions and types of accounts means that even when market circumstances change, you will always be able to generate demand.

Neil Day

Neil Day

The Covered Bond Report

Returning to the issue of second tier covered bonds, how does this tie in with European Secured Notes (ESNs), which were set aside in the legislative package?

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

We were in favour of a three tier approach, where we would have the traditional covered bonds (Pfandbriefe and so on), the directive-based covered bonds, and ESNs. That would have made sure that we had some kind of quality backstop for second tier covered bonds, with the rest being ESNs. This would have set a minimum standard for the second tier covered bonds, because you need some kind of quality floor for them to be successful. But based on my reading of the directive, I’m not really convinced there is room for ESNs now given the broad definition of the second tier covered bonds – and I think among regulators it is also widely understood that we have a broad definition in Article 6.

Matthias Melms

Matthias Melms

NORD/LB

Unfortunately, the European Commission missed an opportunity to write a regulation also for ESNs.

Around six years ago the senior unsecured market was effectively closed at times, and there were discussions within the covered bond issuer community and especially the Pfandbrief issuer community regarding what other types of assets could be used to achieve market access. Not necessarily under Pfandbrief regulation – as one bank did with aircraft Pfandbriefe – or with ship Pfandbriefe, but on another level, using covered bond techniques and bringing assets like SMEs to the market. Then, as market conditions improved, this whole discussion disappeared. That said, we have all been in the market long enough to know that things could change, and it would have been much better to put in place regulation for a product that could offer market access when the senior market is closed, and ESNs would have fit perfectly. If there were then the need for issuers to use assets other than mortgages and public-sector assets to raise liquidity when the senior market is either closed or too wide, for example, they would be better prepared.

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

I’m not convinced that simply by creating any kind of covered product you get access to the market. It’s the inherent quality that makes a product marketable even in difficult times. And the question, even for the second tier covered bonds, is how far down you can go while still convincing investors that it is worth buying these products under difficult market conditions. Simply having three categories of covered bonds – ESNs, directive-based covered bonds and traditional covered bonds – doesn’t ensure that you can use them all when markets are difficult, as you could use the Pfandbrief and some other covered bonds during the deep financial crisis. This is the debate that we have to get on with.

Thomas Ludwig

Thomas Ludwig

Commerzbank AG

I totally agree with Matthias. Currently there is not too much pressure – as even senior unsecured funding via senior preferred or senior non-preferred is extremely cheap – but when we came out of the financial crisis and the Eurozone crisis in 2012 and 2013, funding spreads for banks were far wider than they are today. Therefore, there was far more space between covered bond funding and the senior level. Götz said that perhaps the harmonisation of covered bond laws removes a little of the funding advantage of German Pfandbrief banks – particularly in normal times without QE programmes, there is still a lot of room for differentiation between covered bond laws, and maybe this window will open again, making room for SMEs.

Felix Rieger

Felix Rieger

Deutsche Bundesbank

I personally think that postponing the SME issue from the directive was probably a good idea, because otherwise the process would probably have been too time-consuming to finish in this legislative period. But, also in the long run, I am also not fully convinced that there is a business case for ESNs, simply because there are already other asset classes catering for other assets – we must not forget that we also have structured covered bonds, which have a certain place also in the spectrum of securitised assets, and for two years now we have STS (simple, transparent and standardised) regulation in the ABS segment. I’m not sure that adding an ever increasing number of asset classes helps, because at some stage liquidity is split up between too many different instruments.

Neil Day

Neil Day

The Covered Bond Report

Are extendible maturities something that is still being considered for the Pfandbrief?

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

Yes. We will see how this is viewed by the German government and the German regulator, but it is our aim to introduce an extendible maturity into the Pfandbrief Act. The implementation law in respect of the EU directive will offer an opportunity for this issue to be addressed. Clearly it will comply with the directive, which we were waiting for. Should it be implemented, our aim is that it would apply to all Pfandbriefe outstanding.

Neil Day

Neil Day

The Covered Bond Report

Is such a development welcome?

Matthias Melms

Matthias Melms

NORD/LB

Whether or not you prefer hard bullets, soft bullets, or some other structure, what everyone can recognise is that hard bullet is not the market standard anymore. The only remaining pure hard bullet jurisdictions are Germany, Luxembourg and Spain – we have even seen the first soft bullet covered bonds in Austria. In light of this – and independent of what the EU directive might allow – the question is: can you steadfastly defend hard bullets, or should you not at least offer market participants the possibility to invest in soft bullet structures out of Germany? I really don’t know the answer to that. I don’t have a final view on it. I have heard views, especially from foreign investors, that if they were to invest in the Pfandbrief – which they’re not doing now, because it’s too tight – they would prefer hard bullet, because that’s something they like. Others have said: hard bullet, soft bullet, I don’t care, because I get my money back in time.

Thomas Ludwig

Thomas Ludwig

Commerzbank AG

Currently the difference between hard and soft bullet structures in terms of pricing is pretty thin. But what we still see is that not every soft bullet has the same wording – the terms and conditions are not 100% clear and are by far not harmonised in all jurisdictions yet. Something that has always been very clear and transparent in the German Pfandbrief law is under which conditions something will occur.

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

And it applies to the whole asset class, so it’s for all Pfandbriefe. That’s why it’s important that it is in the law and that there is no leeway in deciding if and how to exercise it. This is one of the strengths of the German Pfandbrief Act, that it is kept simple and applies to all Pfandbriefe.

Felix Rieger

Felix Rieger

Deutsche Bundesbank

What is welcome in the directive is that it now at least says that these extensions have to be defined in national laws. That is perhaps not as good as defining them in the directive, but at least it’s a step in the right direction. And as has been said, the most important thing is that the triggers and the process are defined clearly somewhere and ideally in the law, and you don’t have to dig through long explanations and documentation to find out how it would work. And so if it’s done in a good way, yes, you could think about having extendible maturities in the Pfandbrief law, too.

Neil Day

Neil Day

The Covered Bond Report

Do you buy conditional pass-throughs and soft bullets?

Felix Rieger

Felix Rieger

Deutsche Bundesbank

We only buy soft bullets, not conditional pass-throughs, because there is a difference between a soft bullet and conditional pass-through in terms of the extension risk you ultimately run. If a soft bullet is properly defined, and in particular if it’s not at the discretion of the issuer, then it is something we would be comfortable with.

Neil Day

Neil Day

The Covered Bond Report

With the directive completed, what other regulatory initiatives are there that might be important for the Pfandbrief, for the covered bond market? Basel may be something issuers are focused on, but perhaps this is not Pfandbrief-centric, so to speak.

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

From our perspective, there are three regulatory initiatives that are important.

One is Basel. It’s not a Pfandbrief-centric issue, because Pfandbriefe, or covered bonds, are treated very well there, in terms of the risk weight. But it obviously affects the underlying business, too, and quite significantly so. This directly affects the question of what can be refinanced via the Pfandbrief, and that’s what makes it indirectly important for the Pfandbrief.

The second is the sustainable finance framework as such, which affects all aspects of banking and therefore also the Pfandbrief and Green Pfandbrief or sustainable Pfandbriefe. Whatever way you look at it, this will have a very far-reaching impact over the next few years.

And then on a Pfandbrief-specific matter, you have the mortgage lending value (MLV), where there are initiatives at European and national level. On a European level, they are, for the second time, trying to define a European MLV, which is a good development because it has not existed in the international sphere before, but you have to make sure that they make it right. And at a German level, it’s a question of how to further develop the MLV, which is the basis for the part of a loan that can be refinanced via Pfandbriefe. It is a very static value compared to the market value and the question is how you can take into account the interest rate environment which is unlikely to change any time soon, and what that means for the difference between the market value and the MLV, without hampering the quality of the product.

Götz Michl

Götz Michl

Deutsche Pfandbriefbank AG

In a very well performing real estate market with falling yields, the difference between our conservative and stable MLV and the market value obviously increases. As a consequence, the portion we can fund through the Pfandbrief decreases, so we need a higher portion of senior unsecured funding. In our cover pool we currently have a loan to value ratio based on market values of about 35.2%, a huge difference to the LTV based on the MLV, which is around 55%.

The conservative valuation is key to the quality of the Pfandbrief. However, in a low or even negative interest rate environment, the question of the appropriate minimum property yield for valuation purposes should be discussed.

Neil Day

Neil Day

The Covered Bond Report

We’ll return to the sustainable finance issue later on, but following your comments about interest rates, let’s turn to the market situation. I remember reading analysts forecasts for this year, regarding issuance but also yields and spreads, and things have turned out quite differently to what was anticipated. Matthias, how do developments compare to what you expected?

Matthias Melms

Matthias Melms

NORD/LB

Overall euro denominated benchmark covered bond issuance stands at a little more than EUR90bn, which is pretty convincing. I believe almost every analyst, myself included, forecast positive net supply for this year, but I was the most pessimistic, forecasting a little more than EUR120bn for the full year. That said, when you analyse the reason for the high volume, it’s all down to the EUR38bn of issuance in January, which translated into positive net supply of EUR25bn. Since then we’ve only seen small positive net supply in May, while we saw negative net supply in June and February, March and April were more or less balanced.

We have meanwhile seen spread tightening of around 10bp, with secondary five-year generic Pfandbrief spreads that were around 5bp in mid-January now at levels of around minus 4bp-5bp. There are at least two reasons for that. The first is that the period of positive net supply that put pressure on spreads from early 2018 to mid-January 2019 is over.

The second reason is relative value: the spread between Pfandbriefe and Bunds is at the moment around 45bp in five years, and much more attractive in 10 years. In March 2018 it was completely unattractive, around 25bp, one of the lowest levels since the financial crisis. From March 2018 to January all covered bonds underperformed versus sovereigns and also SSAs, so that by January the situation had changed completely and Pfandbriefe were a screaming buy, especially at the long end of the curve – in 10 years the spread versus a generic bucket of SSAs was around 14bp-15bp, the widest level since early 2013.

Now the situation has changed again. Until today, when Helaba issued at a negative yield of minus 22.8bp, I would have said that it is impossible to issue in the primary market in the short end of the curve and medium maturities. Pfandbriefe are no longer attractive versus Bunds or SSAs. We are talking about deeply negative numbers versus swaps, levels where you normally lose – at least in the long run – demand from bank treasuries.

But now we have the situation where Mr Draghi in Sintra has prepared the ground for possibly another APP and lower deposit rates. If we get APP, we know from past experience that it is possible that spreads will stay in deeply negative territory for a long period if the central bank is buying enough in the primary market – even if we don’t know how big the Euro-System order might be.

That said, we don’t know about TLTRO II repayments, which influence covered bond issuance. I tried to collect numbers from issuers to get an idea of the volumes they took from TLTRO II to refinance their mortgage portfolio, and based on my calculation, I forecast around EUR40bn up to EUR60bn of covered bond issuance next year just to pay back TLTRO II. It appears that issuers don’t consider the TLTRO III conditions to be attractive enough to just roll that part of TLTRO II that refinanced mortgages into TLTRO III, with two years being a little short, without the possibility of rolling it in March 2021.

Thomas Ludwig

Thomas Ludwig

Commerzbank AG

Some very significant external drivers led to the issuance pattern we have seen this year. Firstly, QE – from September onwards the market was well aware that net investments under CBPP3 would soon decrease to zero, and from October spreads widened and there was less issuance activity. Then in January, everyone was well aware of the Brexit date (31 March) but no one was really sure how the market would react if it came to a hard Brexit, and many issuers therefore worked on a frontloaded basis. And during the fourth quarter of 2018 and the beginning of 2019, we saw that at the higher spread levels investors were back and willing to absorb the net supply. If I remember correctly, benchmarks were on average about 50% oversubscribed in 2018 and this year they have been much more than 100% oversubscribed, so the quality of books and the number of participants has increased dramatically. The market has become more attractive from an investor’s point of view again – and this reflects very well on the product, because even if there are certain investors who stood on the sidelines because it was too expensive from a relative value perspective, they returned because they believe in the product.

Felix Rieger

Felix Rieger

Deutsche Bundesbank

It has been a very challenging situation, because there was such a huge level of intervention in the market, and it is natural that when the central bank withdraws there is a lot of volatility. I would therefore not read too much into the way spreads went up and then back down shortly afterwards – I would interpret this as simply a reflection of the uncertainty in the market. Now the situation is perhaps even more complicated, because there are already expectations that the central bank might return, but nobody knows when or how. It’s therefore very difficult to make any predictions, because it also depends very much on fluctuating expectations regarding the business cycle – is a recession coming or not? However, I personally would not be surprised if spreads remain very tight for a long period, with a high degree of volatility along the way – after all, in this environment of high uncertainty you have a flight to quality, and as we said, Pfandbrief and covered bonds are a very high-quality product.

Neil Day

Neil Day

The Covered Bond Report

How have issuers found the market?

Felix Zillmann

Felix Zillmann

Berlin Hyp

We are in line with our issuance plans – we also did some prefunding last year.

The market is challenging, with such tight spreads and negative yields. It was good to see Helaba issuing today in five years because that had also been a question for us – everybody was issuing in the long part of the curve, but at the end of the day you have to balance your assets and liabilities and with commercial real estate we have an average maturity of around seven years, so we can’t go to the long end of the curve the whole time. I assume the order book was driven by banks, but the question is, how will the situation be dealt with by real money investors. I’m glad to hear Felix, for one, still finds the Pfandbrief attractive. Given that the spread differentials between different covered bond jurisdictions have narrowed, the spread give-up investors face when buying Pfandbriefe versus other covered bonds has gotten quite small over the past few months, and if I were buying covered bonds I would go for the product which offers the highest quality and lowest volatility.

Götz Michl

Götz Michl

Deutsche Pfandbriefbank AG

To emphasise Felix’s point on the asset-liability mismatch: the low, negative swap rates have driven investors to longer maturities. At pbb, we postponed the issuance of a second euro-denominated Pfandbrief planned for the end of the first quarter because of the negative carry for our cash position. From a pure opportunity cost perspective, it was the right decision. We saw new issuances pushed further out along the curve, but the Helaba trade with a five-year maturity was a positive signal for issuers who need shorter maturities.

On the asset side, our duration is less than five years, which is typical for the commercial real estate business. The liabilities we issued this year in euros have an average maturity of eight years. With the falling interest rates this might even increase. We have therefore focused on foreign currencies. In US dollars and Swedish kronor we were able to issue in the three year bucket. We will continue to focus on non-euro Pfandbriefe as long as we have assets in that currency. Another option, which Matthias already mentioned, is the TLTRO III, which is a bit short. It might anyway be an alternative to cover the shorter maturities.

Thomas Ludwig

Thomas Ludwig

Commerzbank AG

If you bear in mind that the TLTRO is not a one-off, but a series of seven opportunities, and you already know that you will be fully allocated, you can already plan for that. And if you are currently engaged in the TLTRO IIs, you can roll it when it comes to maturity. Of course, from a regulatory perspective, two years is not so helpful, but from a pure liquidity and cost efficiency perspective it at least offers an alternative at the short end for everyone. Additionally, we may see some more measures from the ECB in September. Most market participants believe that if we see a reopening of the purchase programmes in whatever format, that will lead to further spread tightening, and so after being frontloaded in Q1, issuers can now look at the market on a relatively relaxed basis, especially if you bear in mind that an overhang of liquidity generates negative carry.

Neil Day

Neil Day

The Covered Bond Report

Returning to the topic of sustainability, how do you see the market developing, how are regulations and initiatives influencing activity, and what initiatives are you undertaking?

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

Clearly it’s a topic that extends far beyond the Pfandbrief, and it’s one of the few trends that is here to stay. In my career in the financial markets there have been many fashionable trends and many of them have disappeared quite quickly; sustainability will not but will encompass the whole financial industry. There is a strong political will to use the financial industry to green the real economy, because politicians have seen that they are not able to reach everyone directly, which is why they do it indirectly by this type of regulation. This will be one of the key policy initiatives for the new Commission and many other regulators and policymakers are already working on it.

It is a goal we all share, but my feeling is that actually everybody is doing something about sustainable finance – central banks and regulators, among others, at a national level, an EU level, and a global level – but they are not all speaking to each other. There is therefore a risk that we will end up with different frameworks for the same issues, which then affects the whole financial industry. It is very important that policymakers and regulators coordinate among themselves. We at the vdp are therefore monitoring and engaging with all these initiatives that affect the issuers’ business, both on the asset side and on the funding side.

On a smaller scale, the vdp is taking over the brand “Green Pfandbrief” from Berlin Hyp and will be the central licencing point, so to speak, for Green Pfandbriefe in the future. We are building on a lot of work already done by Berlin Hyp on standards for Green Pfandbriefe and are developing them further in a working group, which will also be in charge of granting the licence. We are also considering social Pfandbriefe as a second pillar of sustainable Pfandbriefe and are discussing relevant standards. This is closely interlinked with all that is going on at a broader regulatory level in terms of the EU taxonomy issue and so on.

Felix Rieger

Felix Rieger

Deutsche Bundesbank

The Bundesbank is quite active on the policy side regarding sustainability. The Bundesbank was a founding member of the Network for Greening the Financial System (NGFS) of central banks and regulators, where more the macro perspective is discussed: How should financial stability be influenced? What can central banks do to really make the financial system greener? And how should this influence regulation on the micro level?

But this is also a very big issue when it comes to managing the pension portfolios for the public investors, the German states and the German central government. Until now it has been more focused on the equity side – where it might be more relevant – but increasingly there is the desire to have a sustainability approach in fixed income.

In my view, there is a huge potential for green covered bonds, for instance. I’m sure there will be great demand, but it’s still a niche market and it’s very difficult to invest large amounts of money in green covered bonds simply because there are not so many. Why is that? Maybe it’s because in the end the cost and the effort for issuers is quite high – there are of course institutions that have made the effort, but apparently others are a bit more reluctant, otherwise we would already see more in the market.

With respect to Pfandbriefe and covered bonds, the question is also, what is the focus of the sustainability approach? Is it the product, or is it the institution? I have heard different views and I’ve not made up my mind completely. One of the basic features of a covered bond is the cover pool, but in many cases the approach is to look more at the issuer. If in the end the standard is more to look at issuer, then maybe in the long run the potential for green covered bonds will be somewhat limited.

Felix Zillmann

Felix Zillmann

Berlin Hyp

The market is quite new, so it has to develop, and we need to be careful that it goes in the right direction. I agree with Mr Tolckmitt that it’s a trend that won’t disappear, because this is not only a financial topic, this is a social topic, a political topic, and both these factors also influence investor demand. When we talk to investors, it’s increasingly important for them to see what we are doing with their money, they really want to do impact investing, and that’s why the trend won’t disappear.

We are pleased that the EU and the Technical Expert Group are putting so much work into the topic. The updated version of the taxonomy from 18 June really contains a lot of positive new points.

We are very pleased to see that the vdp acknowledges the importance of the product. By transferring the trademark to the association, we have the chance together to increase the potential and impact of the brand as more issuers from Germany will use it. In the end we should end up with a minimum standard, to make things easy for investors as well, so that they know that when there is a Green Pfandbrief on the screen, they can expect at least a certain level. This is also what the EU is trying to do, of course, but I think we will be a bit faster, and can maybe set a good example.

Matthias Melms

Matthias Melms

NORD/LB

So far the Green Pfandbrief has given issuers the possibility of enlarging, diversifying and broadening their investor base. In particular, you have much more demand from foreign investors who do not buy the traditional, tight Pfandbrief product – it is really good to see that investors from abroad are buying the green Pfandbrief in size. So, this green product has not only the beauty of hopefully saving our future, but also, for the German issuers, the beauty of offering access to investors they normally do not reach.

However, I can’t identify a greenium for the product at the moment, not only in Germany, but also issuance from other jurisdictions or in other currencies, such as Swedish kronor.

Neil Day

Neil Day

The Covered Bond Report

Goetz, you mentioned you were a bit concerned about the competition for investors with the directive coming in. Would a Green Pfandbrief potentially offering you more foreign investors be an interesting proposition? And are you moving in that direction?

Götz Michl

Götz Michl

Deutsche Pfandbriefbank AG

Clearly, it’s an important topic. But taking a step back from green bonds and the capital market, first of all it’s important to get the bank into a sustainability framework with an overall smaller environmental footprint. This means looking at energy consumption for our offices, IT, travel policy, etc, but also waste management. Then there’s the second question, what kind of business do we underwrite? In our case, being a specialized lender for commercial real estate, it is rather straightforward as building standards are always improving.

With such loans we have the option of issuing green capital markets products – senior unsecured, Pfandbriefe, AT1 – whatever makes sense. And as Jens and Felix have said, demand from investors exists and is actually growing.

I’ve two general comments on the product green bonds. It is not the funding advantage that makes green bonds attractive, as the spread differential is minimal and the additional effort for asset selection, monitoring and reporting is high. But green bonds will allow the diversification of the investor base and – more importantly – supports the environmental cause. Having said that, I think we must not allocate green bonds exclusively to new “green investors” but continue to serve our established investor base as well.

I think there is a very interesting idea in the market that is worth mentioning. The Deutsche Finanzagentur and the Danish government are considering separating the “cash bond” and the green feature. If I understand the concept correctly, there will be a “promise to behave green” for a certain amount with an ISIN that can be bought independently from the government bond. This will put a price tag on the green feature and we will see which investors are really willing to give up return for the environment. On the bond side, the allocation process remains untouched, with only one outstanding benchmark curve driven by the credit quality of the issuer.

Overall, the sustainability trend is very positive, but it’s at an early stage and needs to be developed and improved. This is, for instance, the case with the impact reporting for CO2, where the numbers are often theoretical, not reflecting the real consumption. The question which always remains is whether green bonds really avoid any CO2.

Felix Zillmann

Felix Zillmann

Berlin Hyp

You’ve raised a few interesting points.

First of all, regarding the greenium, I would say that prices are always a matter of supply and demand, and we have definitely seen higher demand on our green bonds, even if we decided to price them on our credit curve. The reason we don’t really see a greenium right now is the compressed spread levels. If you look at KfW’s secondary curve, for example, the green bonds are trading tighter, but this could be due to other reasons – smaller size, for example. Perhaps in other times a greenium would be more visible.

On the other hand, yes, you are right, you have to put a lot of work and money into it. But the investors do that, too. Of course, they look at what the rating agencies say, but they also want to have their own view, so they need to have a certain analytical capacity that they have to spend money on.

Regarding investors and treating them differently, we are currently in an evolving environment. Over the past two years the issue of climate change has become more and more important to everybody, so you don’t just have the usual green investors asking how sustainable you are and what you are doing with your green bonds, suddenly you also have conventional investors asking such questions as they start to change. This takes time, but in a few years you will really have to justify yourself if you don’t issue impact bonds – although I expect the barriers to entry and the workload will then be lower, too.

My last point is on the question whether we save CO2 by issuing green bonds. While our green bond activity is prominent in the capital markets, it of course has a corresponding impact on the asset side. Banks have to be a sparring partner for their customers – we can incentivise them and offer them advice on their green projects – and thereby create a real impact. This is another aspect we are working on with the vdp, the Energy Efficient Mortgages Initiative, which is trying to set standards for green mortgages, and also for how private customers can consult a bank to find out how to make their home more energy efficient and also save money.

Thomas Ludwig

Thomas Ludwig

Commerzbank AG

When we discuss the real difference between energy efficient green buildings versus “old brown” buildings, in the future this may lead to a differentiation on the asset side in terms of lower capital costs or lower funding costs. But bear in mind that for the green bonds we are typically talking about the best 15% of the buildings qualifying as green, and the other 85% need to be financed as well, so there should be room for both products.

Jens Tolckmitt

Jens Tolckmitt

Verband deutscher Pfandbriefbanken

Having regulators and policymakers define rules and push the market in this direction will help steady the sustainability trend and lead to standardisation as an indispensable development. But if you look at balance sheets of banks, the larger part is and for the foreseeable future will remain non-green, and you cannot force the issue. Looking back at the last five years in the Pfandbrief market, what has been very positive has been that the relevant developments have been investor-driven. Investors’ perception of what qualifies as green or sustainable has changed dynamically, and it’s important that regulators understand that while they can set important standards regarding what is considered green, they should refrain from trying to regulate each and every detail themselves but instead leave room for issuers and investors to continue the valuable private initiatives that were in the market long before any politician or regulator discovered the topic and got involved.