The Conundrum of Covered Bonds
Covered bonds, traditionally associated with European finance since the time of Frederick the Great, are now becoming an important part of U.S., Canadian, and Asian finance. In these jurisdictions, market observers and government officials perceive the safety of covered bonds as an antidote for some of the problems that led to the recent financial crisis. Observers are confused, however, about the precise nature of covered bonds and about the relationship of covered bonds to secured bond financing and securitization. This article deconstructs covered bonds, examining their utility as a financing tool, analyzing their legal rights and obligations, studying their relationship to secured bond financing and securitization, and comparing their costs and benefits. Covered bonds can offer real benefits. Like securitization, they can provide access to low-cost capital market funding at low risk to investors, and they can also be used to regenerate lending markets. Covered bonds are more likely than securitization, however, to harm unsecured creditors, to whom they shift all risk of loss. Whether that risk should be allowed to be shifted so asymmetrically is a policy question for any nascent covered bond regime.