Covered Bonds a degradation to existing depositors’ rights

South Africa’s bank regulators are considering allowing banks to issue covered bonds – a move that has raised concern amongst existing bond holders.

Covered bonds are senior debt of banks which have the right to take certain high-quality assets of the bank in case of liquidation. In normal times, Covered Bonds would rank equally with depositors and bank senior debt, but in liquidation would be strongly protected to the detriment of other bank funders.

Andrew Canter, chief investment officer of Futuregrowth Asset Management, believes that the introduction of covered bonds in SA would prejudice existing creditors, including depositors.

“As a large institutional investor in South Africa, we do not think covered bonds should be introduced,” he said. “We think it is a serious degradation to existing investors’ and depositors’ rights.”

“There is no history of secured debt issuance by South African banks, in fact it was blocked by capital regulations, and all current bank funders have invested on that basis.”

“The introduction of covered bonds is a fiat change of regulation, which has material consequences for depositors by reducing their protection from badly managed banks.”

“This introduction is putatively driven by Basel liquid-asset requirements. But since bank regulations are being strengthened partially to protect depositors and funders, it is entirely incongruous to subordinate and degrade the public’s position in such a manner.”

A phasing-in period would be incredibly important, said Canter, who believes that if a law is introduced, the asset class should be introduced gradually over a five to 10 year period in order not to immediately degrade outstanding instruments.

“Asked today if we would support the idea of covered bonds, the answer is, no, we would not,” he said.

“If there is cause to do it, and the Reserve Bank feels there’s good reason, then it must be done over a long period of time or alongside the introduction of very extensive deposit insurance so that the current depositors and bondholders will not be harmed.”