Eddielogic

– Thoughts on Strategy and Management

Financial crisis hits the German market for covered bonds

| 1 Comment

Security and liquidity are important issues in bond market. Now the financial crisis and the general uncertainty (due to the subprime crisis) have an impact in the market for covered bonds (so called Pfandbrief). Dealings of them have come to rest.

In regular times securities traders generate their income from turnover – the more the merrier. But in this situation the opposite perspective has come to life. At least in the covered bond market this situation seems to be the standard routine – to avoid turnover – these days. According to one of the leading German newspapers (FAZ) bond dealers argue to have technical problems if they receive a call to buy bonds. Furthermore it has been reported that bond traders did agree on a so called “non-aggression pact” – traders agreed not to phone each other to avoid distressing situations.

To understand this strange situation we have to look at the dealing procedures in this market. Opposite to equities there is no electronic trading system for covered bonds. Instead this type of bonds is traded via phone by professional traders of several banks. Underwriting banks that received fees from the issuers, agreed to take care for liquidity and pricing (so called “market cultivation”). Hence their traders have to announce prices and spreads for bond trading. Since August 2007 this obligation has been stopped several times but was executed again after a certain period of time. In 2007 for the stop underwriting banks made a formal decision. This time there is no formal decision. However bond trading is nearly stopped. The reason for this informal stop can be found in price fluctuations. In a situation where a bond trader cannot sell his bonds he has to set up a short position to reduce interest rate risk. But hedging has become more difficult these days, in particular for Irish, Spanish and UK bonds. Due to larger price fluctuations traders do not want to have bond positions in their accounts.

That’s a strange situation. Due to their features covered bonds can be described as very safe investments. Their link to the US subprime crisis does actually not exist. “Pfandbriefe” are regulated by law and have a nearly 200 year history. Due to their coverage there was no shortfall of “Pfandbriefen” in the last 100 years.

LIKE WHAT YOU'VE READ? If so, subscribe to our mailing list. Just enter your best mail address and press the Subscribe button!

One Comment

  1. Nice site I am surfing same theme with my site

Leave a Reply

Required fields are marked *.