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n November 15 a group of eight European covered bond issuers

from six different covered bond regimes met in London at the offices

of UBS Investment Bank to converse via video conference with five

Australian investors. The discussion – lead sponsored by UBS Investment Bank

and Standard & Poor’s, with Mallesons Stephen Jaques as a

co-sponsor – aimed to give the borrowers an idea of what drives Australian fixed

income institutional investors, while at the same time provide further education

for investors on this growing asset class in the Kangaroo bond market.

The investors highlight the importance of liquidity and transparency in the context

of the role the Asian bid plays in the Kangaroo bond market, while the issuers

debate whether covered bonds is a homogenous asset class and point out the

differences between covered bonds and residential mortgage-backed securities.

LONDON PARTICIPANTSAYT Cédulas Cajas, David Nogales Álvarez, DEBT CAPITAL MARKETS Bradford & Bingley, Mark Winter, HEAD OF FUNDING AND CAPITAL MARKETS

Cassa Depositi e Prestiti, Monica Tamisari, DEBT CAPITAL MARKETS Compagnie de Financement Foncier (CFF), Sean Smatt, DIRECTOR,PUBLIC ISSUANCE Dexia Municipal Agency, Florence Lemonnier, DIRECTOR, INVESTOR RELATIONS and Véronique Hugues, HEAD OF LONG-TERM FUNDING

DESK EuroHypo, Marcel Kullmann, HEAD OF FUNDING Hypo Real Estate Bank International, Patrick Steeg, HEAD OF FUNDING

SBAB, Per Tunestam, COVERED BOND FUNDING Mallesons Stephen Jaques, Rowan Russell, PARTNER Standard & Poor’s, Karlo Fuchs, ASSOCIATE

DIRECTOR, EUROPEAN COVERED BOND RATINGS UBS Investment Bank, Armin Peter, DIRECTOR, HEAD OF COVERED BOND SYNDICATE KangaNews,Samantha Swiss, MANAGING DIRECTOR

SYDNEY PARTICIPANTSColonial First State Global Asset Management, François Kong, SENIOR PORTFOLIO MANAGER and Justin Tyler, PORTFOLIO ANALYST

ING Investment Management, Gavin Andrew, SENIOR CREDIT ANALYST State Street Global Advisors, Dr. Stephen J. Nash, HEAD OF FIXED INCOME

AND CASH Tyndall Investment Management, Roger Bridges, HEAD OF BONDS Mallesons Stephen Jaques, Ken Astridge, PARTNER and PhilipHarvey, SENIOR ASSOCIATE UBS Investment Bank, Andrew Clark, director, FIXED INTEREST SALES KangaNews, Kimberley Gaskin, CONTRIBUTING EDITOR

COVERED BONDS UNCOVERED

David Nogales Andrew Clark Gavin Andrew Stephen Nash Ken Astridge

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WE HAVE EIGHT ISSUERS REPRESENTED IN LONDON, FOUR OF WHICH HAVE ISSUED IN THE KANGAROO BOND MARKET, THREE OFTHESE IN COVERED BOND FORMAT.

� STEEG Hypo Real Estate Bank International (HypoInternational) issues both mortgage and public sectorPfandbriefe. This year we have placed both types ofPfandbriefe in the Kangaroo bond market, as well as a seniorunsecured issue. We’re very pleased that the covered bondmarket has now reached Australia. Hypo International’sfunding volume for 2006 is €18 billion (US$23 billion).� TAMISARI I run the covered bond programme at Cassa

Depositi e Prestiti (CDP), which is a specialised lender to thepublic sector in Italy. Since its inception CDP has been the stateagency in charge of financing public sector investments in Italy.In 2003 CDP was transformed from a public sector entity intoa joint stock company, majority owned by the Italian state, so asto adapt to the evolving regulatory framework in its referencemarket. Following this transformation, CDP continues to bemainly focused on financing public sector investments.

The company has been able to issue covered bonds owingto specific provisions on asset segregation law. On the back ofthis, CDP set up a covered bond programme in 2004 for theissuance of triple-A rated covered bonds. The proceeds ofthese bonds are used to refinance CDP’s core business. Weentered the market in 2005 and so far we have issued fourseries of hard bullet euro-denominated, fixed rate coveredbonds for a total outstanding of €8 billion. We will continue toissue covered bonds on a regular basis as these securities havebecome the preferred source of funding for CDP’s publicsector lending business. Our funding volume for 2006 will be€4 to €5 billion.� TUNESTAM I represent Sveriges

Bostadsfinansieringsaktiebolag (SBAB)’s covered bonddedicated subsidiary called the Swedish Covered BondCorporation (SCBC). We made our entrance into the coveredbond market about six months ago when we transformed ourdebt on an unsecured basis into covered bond format.

During the past six months we have entered three different

markets – the Swedish covered bond market, the euro jumbomarket, and yesterday we entered the Swiss covered bondmarket. So it has been a rapid development for us, and we nowhave an outstanding debt of €7 to €8 billion in covered bonds.We do any type of funding in various currencies – and we lookforward to investigating new possibilities with our funding. Wewill be a regular international issuer going forward.� LEMONNIER I represent Dexia Municipal Agency (Dexia MA),where I’m in charge of investor relations. My colleague,Véronique Hugues, is in charge of the long-term funding deskin Paris, running the programmes of Dexia Crédit Local andDexia MA. Dexia MA is a French société de crédit foncier which hasbeen issuing obligations foncières since 1999. Dexia MA ischaracterised by a specialisation in public assets, most of whichare originated by the Dexia Group.

Apart from the high quality of its assets, Dexia MA enjoysa simple and robust balance sheet and a stringent asset andliability management policy. Dexia MA’s funding programmewill reach roughly €12 billion in 2006 and it relies on two pillars.The first is the building of benchmark curves in differentcurrencies and markets. This includes euros but we alsodiversify into other currencies and markets, such as US dollars,Australian dollars, sterling and Swiss francs. The second pillarconsists of private placements, where Dexia MA is particularlyactive, offering tailor-made products adapted to investors’specific needs.

We set up our Kangaroo programme in 2002, which todayamounts to A$5 billion (US$3.8 billion). Dexia MA has built acurve in this market, which comprises seven benchmarktransactions totalling A$2.3 billion, in maturities ranging from2007 to 2015. This year our curve has been added to by onenew benchmark maturity and two taps.� KULLMANN Before joining EuroHypo earlier this year I was atLandesbank Baden-Württemberg, where I first gainedexperience in the Kangaroo bond market. EuroHypo is asubsidiary of Commerzbank, Germany’s second-largest bank.EuroHypo has total assets of just over €220 billion, whichconsist of about 45 per cent real estate assets and 55 per centpublic sector assets.

The covered bonds we issue are under two jurisdictions –Luxembourg and German law – although we issue most underthe latter. We have €115 billion of outstanding covered bonds.

Philip Harvey François Kong Roger Bridges Justin Tyler Mark Winter

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Of that, €14 billion is non-euro denominated, while €46billion is in jumbo Pfandbriefe.

This year EuroHypo’s funding volume will reach closeto €25 billion.� SMATT Compagnie de Financement Foncier (CFF), a sociétéde credit foncier under the French legal framework, wasfounded in 1999. Under that framework and given ourprudent approach to asset and liability management,security and stability are what characterise our issuance ofobligations foncières. Public sector loans representapproximately half our total assets.

We have a total balance sheet of approximately €65billion to June 30 2006, with a split between mortgage loansand public sector assets – the latter being the largest growtharea for us right now.

Our funding is done through four main channels –benchmark issuance in euros and US dollars; taps of thoseissues to provide liquidity as necessary; private placementsto provide structures according to investor needs; and non-euro and non-US dollar benchmarks – including those wehave done in the Australian market. That is an importantpart of the diversification of our funding.

This year the funding programme will end up at around€17 billion. Therefore, the diversification we achieve in theAustralian and other markets is an extremely important partof our growth. Right now we have two existing lines inAustralia – a A$200 million February 2010 and a A$600million September 2015. We look forward to developingour yield curve further.� NOGALES AyT Cédulas Cajas is the covered bond issuer ofthe Spanish savings banks. Cédulas – Spanish covered bonds– comprise the second-biggest covered bond market inEurope, and AyT Cédulas Cajas is the main player with a market share of nearly 25 per cent. We startedissuing in 2001 and now we have an outstanding volume of €50 billion. Our funding volume for 2006 will be above€14 billion.

Last year we established AyT Cédulas Cajas Global – aprogramme that allows us to issue in a more flexiblemanner within the cédula product.

So far, we have only issued in euros, but thisprogramme also allows AyT Cédulas Cajas to issue in other

currencies and we are working on being able to issue in USdollars – hopefully from 2007.� WINTER I’ve just recently come back from a non-dealroadshow in Australia for Bradford & Bingley. What wasinteresting from that roadshow was the growing interest inbringing covered bond transactions in Australian dollars.

We have a £10 billion (US$19 billion) covered bondprogramme through which we’ve issued in euros, and thisyear we diversified into Swiss francs. We are looking todiversify further into other currencies. Particularly high onthe agenda would be Aussie dollars – depending on therelative economics when swapped back into sterling-Libor.

Bradford & Bingley’s funding volume for 2006 will total£6 billion.

WE ALSO HAVE BOTH MALLESONSSTEPHEN JAQUES AND STANDARD& POOR’S REPRESENTED IN LONDON.� RUSSELL Mallesons Stephen Jaques is an Australian lawfirm which operates in Australia, Asia and the UK. We havea large capital markets business and we’ve worked on themajority of the Kangaroo issues. Our firm has recentlyfinalised a covered bond programme for one new issuerand we’re in the process of documenting another.

We can provide services from London – where we have12 lawyers – or from our main offices in Sydney andMelbourne. In Sydney today Mallesons is represented byKen Astridge and Philip Harvey.� FUCHS Standard & Poor’s (S&P) has rated covered bondsfor about a decade. In 2006, S&P formally set up a coveredbond rating group with analysts solely dedicated to coveredbonds. Geographic and volume growth as well as issuer andinvestor interest drove this decision.

Actually, S&P has accompanied the market from itsinfancy in the 1990s and today the team covers bothtraditional and structured covered bonds. The former arethose where issuance is enabled by legislation and where inthe first step we have to analyse whether the legislation isstrong enough to allow us to employ a de-linked ratingapproach even in case of the insolvency of the issuing

Monica Tamisari Sean Smatt Véronique Hugues Florence Lemonnier Marcel Kullmann

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bank. Structured covered bonds are typically issued incountries where there is no legal framework (such as the UK). Here we have to analyse whether the structuresthemselves are robust enough to also have the assignmentof a triple-A ratings, by solely focusing on the ringfenced assets.

THERE ARE FIVE INVESTORS IN SYDNEY. WHAT IS YOUR INTEREST IN COVERED BONDS?� KONG Colonial First State Global Asset Management (CFSGAM) has large amounts of money to invest, from triple-Ato sub-investment grade. Our total funds undermanagement in fixed income and cash is A$44 billion.

I’m here to try to understand more about covered bonds.We have invested in covered bonds – although back in 2001when we bought Dexia MA’s inaugural Kangaroo bonds weprobably didn’t realise they were classified as covered bonds.We knew what we were getting into, we were comfortablewith the name and the bond we were buying, but we didn’tfully appreciate that we were getting into what is commonlyknown as a covered bond investment. We have also investedin Hypo International’s covered bonds this year. And we’veinvested in CFF’s Kangaroo obligations foncières.

It is an interesting sector – and while many Australianinvestors look at triple-A Kangaroos as a homogenoussector, we at CFS GAM do not. We look at each issuer onits own merits. So we wouldn’t say we like covered bonds,therefore we’ll invest. It’s more a case of looking at eachindividual borrower coming to the market.

Slowly we are learning that covered bonds is a very bigsector in Europe and if the issuers in London today arelooking to issue here in Australia, we’d like to understandmore and know why you are looking beyond Europe. Itlooks like you already have a very big investor base, happyand prepared to buy your bonds, in Europe.� TYLER I work at CFS GAM, with François Kong. I’m hereto learn more about the covered bond sector. We have someknowledge of the various structures that are available, butthis is the first time I’ve had an opportunity to hear fromsuch a variety of issuers.

� ANDREW I’m a senior credit analyst with ING Investment

Management. We are part of a global integrated fixedincome team, which globally manages A$420 billion across26 countries. Locally, we have a fixed income team of 11 people, which manages around A$14 billion infunds under management. We’ve invested in coveredbonds on a selective basis.� NASH State Street Global Advisors has A$14 billionunder management in fixed income and cash in Australia.We have seen of late that some clients are not veryinterested in credit. They typically invest in governments,and although there was in the past an interest in investingin supranationals as an alternative, this occurred when the supras were wider to swap. The recent tightening of supras has reduced their relative value, so the coveredbond sector could present another alternative for our clients.

It would be easier for our clients if the covered bondsector was represented in a separate sub-index, but Iunderstand that with the low levels of issuance to date inthe Australian market this would be quite difficult.

We also generally require more diversity in our bondportfolios, so seeing new issuers interested in our marketis a welcome development.� BRIDGES Tyndall Investment Management has A$5billion under management in fixed income and cash. Thefirm is part of the Promina insurance group. As a result, afair amount of our fixed income holdings covers theinsurance group’s liabilities. These liabilities have beenmatched to high-quality debt. So triple-As represent quitean important sector for us, including the covered bondmarket. I concur with Stephen Nash that our job is tomaximise the risk-free to swap rate pick-up while at thesame time not allowing credit quality to deteriorate.Therefore, triple-As have represented good value for us.The problem we’ve seen is that in recent years the triple-As we have been investing in – the supranationals andagencies – have gone sub-swap and are running into thesemi-government bond levels. So we’re looking foralternative assets which will trade around the swap-flatlevel, giving us a small pick up compared with thegovernment and semi-government yield curves.

Patrick Steeg Rowan Russell Per Tunestam Karlo Fuchs Armin Peter

DO INVESTORS INAUSTRALIA VIEWCOVERED BONDS AS AHOMOGENOUS SECTOR?

Kong At the moment I can’t

see how covered bonds can

be treated as a homogenous

sector, especially considering

that there are so many

different legislative regimes.

With supranationals, for

example, we have reached the

stage in our market where

there is a healthy curve across

three or four names, all

trading quite well. So if we are

looking for a supra in a

specific maturity, we can

generally find it from one of

the issuers in the sector. But

with covered bonds, I feel that

at this stage that would be

difficult – one covered bond is

not the same as another.

Winter Isn’t that the role of

the rating agencies – to give

investors comfort in investing

in bonds from different

jurisdictions?

Fuchs Yes, the rating is a

common denominator and for

most covered bonds it is triple-

A. But we also stress to

investors that there is more

risk in a covered bond than

just the credit risk that is

addressed by the rating.

However, I’d still argue that

covered bonds is one common

asset class, despite the fact

that risks behind the different

covered bonds can vary.

As a rating agency, we see our

role as ensuring that the risks

of individual issuers are for a

given rating level adequately

buffered by what usually is the

Is covered bonds a homogenous asset class?WITH A TOTAL OUTSTANDING OF €1.8 TRILLION

(US$2.3 TRILLION) AND ISSUERS FROM OVER 20

COUNTRIES NOW INVOLVED IN THE EUROPEAN COVE-

RED BOND MARKET, AN IMPORTANT QUESTION FOR

INVESTORS IS WHETHER COVERED BONDS IS

A HOMOGENOUS ASSET CLASS.

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over-collateralisation. Given that

the over-collateralisation might

erode over time, and that the

adequacy of over-

collateralisation might also

change due to changes in the

asset mix, we want to highlight

to investors that they still need

to monitor their investment.

Although we get all the

information needed to assess

risks relevant for us, issuers

should also regularly provide

information to investors on the

asset composition and other

risks to allow them to make an

independent assessment of

whether the potential volatility

still fits into their risk tolerance.

In Europe the market for

covered bonds is very large, with

€1.8 trillion outstanding. A big

proportion of this comprises the

jumbo covered bond segment

that typically has individual

issuance sizes exceeding €1

billion. Looking at issuers in the

jumbo market you’ll realise that

they might be exposed to some

form of liquidity risk when it

comes to the maturity of those

jumbo deals. Having the ability

to also tap the tailor-made/non-

jumbo covered bond markets

such as the Kangaroo market is

therefore a positive from a

rating agency point of view. It

allows issuers to much better

match their asset profile with

their liability profile. This non-

jumbo market is also attractive

for investors who are looking for

certain risk structures and

maturities to fit in with their

respective needs.

So triple-A is triple-A but

investors need to watch out for

the potential risks that might be

in a cover pool. Usually they are

quite low because the issuer is

not allowed and not willing to

run that much risk. But still, the

potential risks vary from

jurisdiction to jurisdiction and

that is why it is important to

look at not only the rating but

also the individual issuer’s risk

profile to ensure that it is

adequate for each investors’

respective investment

philosophy.

Tunestam I would argue that

covered bonds is a homogenous

sector. If you draw parallels from

the residential mortgage-backed

securities (RMBS) market,

everyone here views the RMBS

market as being homogenous,

despite the differences between

WHY ARE THE ISSUERS INTERESTEDIN THE AUSTRALIAN MARKET WHENTHEY HAVE SUCH A DEEP INVESTORBASE IN EUROPE? � PETER Having a natural hedge is one element, another isinvestor diversification, as is cost. But the rating agencies arelooking more and more into how borrowers fundthemselves as well, and any diversification in terms of howthey fund and the breadth of their investor base is a keyelement in a company’s rating quality and strength.� FUCHS That’s right. Having a diverse investor base addsstability to a bank’s counterparty credit rating. But withregard to covered bond ratings, the main issue is that ifissuers have Aussie dollar assets registered in the coverpools, we favour them being able to hedge that withissuance in Aussie dollars rather than having an open FXposition (in the case of insolvency). Being able to employnatural hedges is usually the most efficient way to mitigate the risks of a covered bond programme.

� TAMISARI As far as CDP is concerned, the company is arelative newcomer to the covered bond market – we enteredthe market for the first time in 2005. During the first stagewe looked at Europe as the core market for covered bonds.But now we have built a curve and established ourselves as aregular issuer in the core market, we are looking at othermarkets so as to expand our investor base.

We have set up all the documentation for entering into swap agreements so we can start issuing bonds privatelyin different currencies, maturities and structures,to offer investors tailor-made products. So we arelooking at currencies other than euro, including US andAustralian dollars.� TUNESTAM SCBC is also a recent entrant into the coveredbond market. So far we’ve been very busy accessing themarkets closer to Sweden. For next year we will start lookinginto the Asian and hopefully also the Australian market. Weare keen to establish true funding diversification, so it’simportant to be present in as many markets as possible.� KULLMANN We are in the last stages of setting up ourKangaroo programme. We have Australian dollar assets, so

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issuers and jurisdictions. The

same thing applies to covered

bond issuers.

If you look around Europe, it is

true that there are 20 to 25

jurisdictions that have

implemented separate covered

bond legislation. But the laws all

have common features.

Tamisari I agree. As far as CDP

is concerned, we issue covered

bonds under a specific legal

framework providing for the on-

balance-sheet asset segregation

of the assets in the cover pool.

This means all the structural

features have been put in place

by contractual agreements,

replicating the standard features

in other covered bond

legislations.

In this respect, it is important to

inform investors that a new

general legislation is about to be

implemented in Italy, which will

allow Italian private sector banks

to issue covered bonds as well,

with CDP continuing to rely on

its own specific legal framework.

Lemonnier I think it is difficult

to say, today, that the covered

bond market is a homogenous

sector in the sense that you

really have, as François Kong

pointed out, different kinds of

legal systems as well as different

covered bond formats. Some

covered bonds are issued under

a specific legal framework, while

others are issued through a

structured format, without

dedicated covered bond

legislation behind them.

In addition, behind the triple-A

rating of the bonds you can find

different business models,

starting with the sector of

activity of the issuer – such as a

purely public sector issuer

versus a purely mortgage issuer.

What we hear from investors

around the world is that they

focus more and more on the

analysis of the various issuers.

And they increasingly study in

detail the business models of

issuers so as to really

understand what is behind the

rating of their covered bonds.

Smatt I agree. As a global asset

class you can perhaps say there

is a covered bond market with

some common elements

between issuers. But there has

to be a multifaceted approach,

looking at the assets behind

each covered bond, the legal

framework, and the type of

rating – triple-As are not all the

same and even the rating

approach to getting to triple-A

can be very different, as is our

case with the structured rating

(see p21). So it’s important to

distinguish between the different

issuers in the market. There are

different risk and return

elements and the fact that there

is increasing differentiation by

investors in the market is a

reflection of the fact that there

are subtle and important

differences.

Tunestam I agree – it’s a two-

phased approach. First you have

to define what you would like to

see in the definition of covered

bond, and there are established

criteria for this definition. The

next step is to start

differentiating between triple-A

and triple-A issuers – looking

into the asset pools and the

business models.

I get the sense that in Australia

you are still facing the first step.

But once you have done that,

you can then start differentiating

between the different legal

regimes and issuers.

Fuchs A lot of people like

icecream, but the question is

what flavour they like most. As

Per Tunestam has correctly

pointed out, some of the main

ingredients in the covered bond

market are the same and all of

those we have looked at

achieved the triple-A rating

because they put in the right

ingredients and the right level of

over-collateralisation. Thus, it’s

really for investors to decide

what flavour they want –

whether they want more of a

public finance flavour, or a

Swedish mortgage flavour.

Peter In terms of the spread

differential between the different

flavours of covered bonds, it is

very minor. I am sure that is

partly as a result of us being in a

low yield and healthy credit

environment. I’m pretty sure

that once the market turns

investors will value the

differences and we will see more

volatility, while those elements

used to distinguish different

covered bonds will come to the

fore. This will bring bigger

spread differentials between the

different types of covered bonds.

issuing in this currency would be a natural way to refinancethose assets – we would not have to swap the proceeds backto euros or US dollars. So we have a natural need forAustralian dollars.

From the investor standpoint, Kangaroo Pfandbriefewould be another product we could offer to existing Asianinvestors – as we have significant Asian participation in our jumbo Pfandbriefe. And we are interested in attractingnew investors.� STEEG For Hypo International there are several reasonsfor us to go to Australia. Like EuroHypo, the first is todiversify our investor base globally. Secondly, we are activeon global commercial real estate markets, outside Germany,and we’d like to diversify into new markets as we would liketo have a natural hedge in Aussie dollars, as well as Swissfrancs, US dollars, Canadian dollars and several other currencies.

However, for us it’s not just a decision based oneconomics – we would not say if the basis swap works wewill issue, if not, we won’t be in your market. We’d like toshow a commitment to the Australian market, which I think

we have done this year by issuing three types of products –the mortgage Pfandbriefe, the public sector Pfandbriefe andthe senior unsecured. We are also considering to come toAustralia with a lower Tier II deal. We also showed acommitment to the Australian market by paying a premiumto enter the market, by not giving arbitrage opportunities.Our aim is to establish liquid curves in all three products –we will be a frequent borrower, whether or not theeconomics work perfectly.� NOGALES We always try to search for new investors –both within the natural market for covered bonds in Europeand in other markets such as Asia, the US and, of course,Australia. To issue in different currencies we have to firstdeal with a legal limitation which at the moment doesn’tallow us to issue in currencies other than euros, as theremust be a correlation between the mortgage pool and thecédula. We are trying to solve that – either by introducing aswap or with some new legislation. Once this is in place, wewill be able to issue first in US dollars, then we hope to beable to follow this up with other currencies, includingAustralian dollars.

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INVESTOR EDUCATION IS CRUCIALWITH ANY NEW MARKET. MARKWINTER, BRADFORD & BINGLEY HADA GOOD EXPERIENCE WITH THESWISS INVESTOR BASE IN 2006.COULD THIS WORK AS A BLUEPRINTFOR HOW TO APPROACH THE KANGAROO MARKET?� WINTER We went to Switzerland at the beginning of 2006 ona non-deal roadshow without any great expectations. As a resultof that roadshow, there was overwhelming support frominvestors for us to bring a deal in their local currency. So whenwe did a large jumbo euro-denominated transaction earlier onin the year, we tacked on a Swiss franc deal, which soldextremely well.

Over the summer there was a lot of reverse enquiry fromSwiss investors. As we weren’t in a position to bring a privateplacement at that time, we decided to launch a four-maturitySwiss franc transaction which was pre-sold before launch. Thepricing we achieved was what we could reasonably expect inthe euro market.

So it was a tremendous opportunity of first educating thelocal investors in what we do for a living and the product, andthen responding to investor demand – by printing maturitiesthey were looking for. That is exactly what we like to achieve inthese kinds of deals – selling into strong investor demand andtrying to give investors a product they want.

ARE TAILOR-MADE COVERED BONDSINTERESTING FOR AUSTRALIANINVESTORS OR ARE THEY MOSTKEEN ON COVERED BONDS AS A LIQUID ALTERNATIVE TOGOVERNMENT BONDS? � CLARK From time to time there are specific liability matchingrequirements that might be matched by tailored issues. But Ithink with the education process that is coming with thecovered bond market, liquidity will be the most attractiveelement of this asset class.

One of the issues about the Australian market is the size ofdeals that can be achieved. We’ve heard a lot about the liquidityof the European covered bond market. Obviously, our marketwould not allow deals of comparable size – out here a A$400million issue would probably be seen as a benchmark size.

Having said that, the Kangaroo market has come a longway from the early days when there was a feeling thatinternational borrowers would be opportunistic, coming to thismarket only when the basis swap worked for them. Now weare developing a track record and issuers are building curves, sowe are seeing better liquidity.

We are also seeing quite a lot of demand for Aussie dollarsfrom non-Australian domiciled investors, including Asiancentral banks, which adds to the liquidity of some deals.� BRIDGES Our market would grow a lot faster if we haveissuers who target deals of A$500 million to A$1 billion, ratherthan a whole lot of smaller issues. One thing that bothers me isthe tapping we’ve seen lately in the Kangaroo bond market.You get a situation where a bond is performing, due to investorinterest, and then the increased interest is met by the issuebeing tapped. Ultimately this discourages the secondary market,and it also doesn’t really encourage investors to hold onto thedeal because they know that if a bond is performing well it willjust be issued into.� SMATT One of the issues in terms of bringing bigger-sizedtransactions in the Australian market is that it is difficult toachieve larger volumes without supplementing the localdemand with Asian investor demand. Doing this to someextent is fine, but if a Kangaroo issue is 80 per cent sold toAsian investors, it’s not really achieving the diversification weset out to achieve – and, from what I understand, it doesn’tseem like the preferred outcome from a domestic investorperspective. If we are able to come to the market with a A$500million deal, do you as investors have limits as to whatproportion of a deal you can buy?� ANDREW From ING’s perspective, there are no hard and fastrules on percentages of an issue. But you have to look at thecovered bond asset class, which is essentially a substitute forgovernment or semi-government or supranationals, so it is notan asset that would fit easily into our portfolios. So there arenatural constraints as to how much of an issue we could hold.� KONG We do have limits for rating bands, depending on themandate. It’s fair to say that the triple-A limits are fairlygenerous so we can take a large chunk once we add up all theallocations across all the portfolios we manage.

Occasionally we come across a transaction where it lookslike we might bid for 40 to 50 per cent of the deal. And thiscan cause us to question whether it is too much and how itmight impact on the liquidity of the issue. Because although wedon’t have specific limits on issues, if we take a large lick weneed to ensure that there are enough investors in the domesticmarket to create a bit of liquidity.

I’m not saying we must be able to trade a large lick througha broker. It’s more a case of being comfortable that there areenough local investors who are aware of the name – especiallywith covered bonds, which is a relatively new sector in ourmarket. The more people who have invested in covered bonds,the better it is for liquidity.� TYLER We are conscious of the proportion of an issue that issold domestically versus the proportion that is sold to Asia.Our perception is that a reasonable proportion of Asiandemand will be held to maturity. So in some cases, due toliquidity considerations, we will scale back our interestdepending on the amount sold to Asia.� HUGUES At Dexia MA we are extremely cautious when

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looking at the allocation of deals because although the Asianbid can drive the price down, we want to ensure pricing is inline with domestic expectations. We are building a globalfranchise and while there are other ways to reach the Asianinvestor base, the priority with Kangaroo bonds is to servedomestic investors.� LEMONNIER So this leads us to ask Australian investors thequestion of issue size versus placement. On the one hand itis true that we are targeting the domestic investor base, buton the other hand we hear from investors that they wouldlike to see the size of issues increasing – in which case wemay see bigger support and participation from Asianinvestors. This means there is a risk that the proportionplaced in Australia could be smaller than the proportionplaced to Asian investors. As a frequent issuer, how do wedeal with this?� KONG You are right – there is sometimes an issue in termsof what size borrowers can bring to the market and theinfluence of the Asian demand. What is most important hereis transparency. Investors need to know what is going on.

Let’s take a situation that could easily happen. We get a callfrom a broker who says there is some reverse enquiry for anissue but it’s only A$200 million and they need A$500 millionbefore the issuer is interested. The broker says they can drumup another A$200 million from Asia, so if there is anotherA$100 million of domestic demand, there is an attractivelypriced deal in the making. So we might say we are interested.

And then once the issue is announced, we find thateither the A$200 million that was supposed to go to Asia

is now A$300 million, or the whole issue does not clearand there is an overhang.

The bankers are just doing their job, trying to bring issuesto the market. But we don’t really know in an ex post factosense what happened between the deal that was initiallydescribed to us and the actual outcome. The lack oftransparency can mean that we are more hesitant next time around.� BRIDGES Having worked on both sides of the fence, I takethe view that whether investors are foreign-based or domestic-based, it doesn’t matter. So as long as they are Australian dollarinvestors, I don’t really care where they reside. What I do careabout is the proportion that is put into any one investor’shands. If the majority of the bonds goes into one or twoinvestors, it’s not healthy for the issue.

So I agree with François Kong – if you get an issue where alot of the bonds are held on the books of the underwriter, it isnot good for investors. And to be quite honest, there is a lackof transparency in this market about the concentration of newissues to one or two investors and also about how much is leftover. In this situation, what you are really saying is that theprice is not allowing the bonds to clear.� CLARK It can be a difficult situation because while the Asianbid for Aussie dollars is not a bad thing, many Asian buyersare relatively passive. So you won’t see the bonds turning over,but it does allow larger issue sizes. And so it’s a balance and atrade-off between getting a benchmark-sized issue andensuring that the bonds will be liquid. If there is a very largelead order I like to let other investors know. Because if A$200

1 5

Tunestam The two markets

are converging – you can see

that in the spread

development in the last two

years. However, there are still

very big differences between

the two assets. An RMBS is

issued by a special-purpose

vehicle (SPV), so it’s off

balance sheet. With a covered

bond, you also have the

assets ringfenced, but they

remain on balance sheet and

in addition, you have specific

legislation and a prioritised

claim, so it takes investors

closer to government risk. I

would say that covered bonds

sit somewhere between

RMBS and government

bonds.

Fuchs I agree with Per

Tunestam that there are

differences and these are yet

two separate asset classes.

Still, convergence in the

analysis has within S&P

already occurred. As the

underlying risks to which the

assets are exposed are the

same regardless whether you

put the assets in a covered

bond or an RMBS

Difference between covered bonds and RMBSDURING THE DISCUSSION, JUSTIN TYLER AT COLONIAL FIRST STATE GLOBAL

ASSET MANAGEMENT ASKED THE ISSUERS WHETHER COVERED BONDS IS REALLY

A SEPARATE ASSET CLASS, DISTINGUISHED FROM ASSET-BACKED SECURITIES

(ABS), OR WHETHER COVERED BONDS AND ABS ARE ON THE SAME RISK

CONTINUUM.

transaction, we analyse them

using the same techniques.

Tamisari One of the major

differences is that in the

covered bond product you

have a revolving cover pool

instead of a static cover pool

like in an RMBS. So with a

covered bond you have the

obligation of the issuer to

substitute a non-performing

asset in the cover pool, which

protects covered bond holders

from a risk of a deterioration

in the credit quality of the

cover pool. Another major

difference between covered

bonds and ABS is that

bondholders benefit from a

residual claim against the

issuing bank, in addition to the

preferential claim over the

cover pool.

Nogales To follow up on the

asset side, in the Spanish

case, an RMBS has a concrete

pool of assets backing the

bonds, but with a cédula, it

also has the whole mortgage

portfolio of the savings banks

backing the covered bond.

This gives us the huge

collateralisation levels we have

on every AyT Cédulas Cajas

issue which is one of AyT’s

major features.

Astridge Also, in an RMBSdeal you don’t have a

watchdog, which has statutory

obligations, monitoring the

pool and the portfolio.

1 6 | K A N G A N E W S D E C 0 6 / J A N 0 7

million of a A$400 million issue is going to someone who isexpected to put the bonds in the bottom drawer, otherinvestors need to know that.� KONG It’s fair to say that without the Asian demand, theKangaroo market wouldn’t be where it is now. There’s nodoubt that it has helped our market. But the market needs tobe more transparent and we will keep asking for this.

DO INVESTORS EXPECT ISSUERS TO BE CONCERNED ABOUTTHE ALLOCATION OF THE BONDS,OR IS THIS JUST SEEN AS THE RESPONSIBILITY OF THE BROKERS?� BRIDGES The borrower has to take a key role. Investmentbanks just want to get the deal out there and they are not thatconcerned about how the deal gets done, as long as the bondsare sold and the bank is not sitting on a big chunk at the endof the bookbuilding process. So even if say 45 per cent of thedeal goes to one investor, the investment bank may not beparticularly interested.� PETER For me as a syndicate person, it would be very inte-resting to know from investors what is the critical mass for thesize of the Asian bid in a Kangaroo deal?� KONG That’s a tough question to answer. Let’s make theassumption Andrew Clark mentioned, that Asian investors arepassive, and let’s say 50 per cent of an issue goes to Asia. Ifour initial bid was for 30 per cent of the whole issue, with halfthe deal going offshore, suddenly we’re holding 30 per cent of50 per cent, which is 60 per cent of what we would considerto be a free float in Australia – using an equity analogy. Now ifthere are only two or three other investors holding the remai-ning domestic portion, to us that is a sign that it is not goingto be a liquid transaction.

On the other hand, if the remaining portion is split betwe-en 10 investors, each with smaller allocations, it is more likelythat the transaction will be liquid. Those investors with smallerallocations may only be holding A$10 million of the deal now,but in a year’s time they may hold A$50 million – that’s becau-se they are aware of the deal, they are up to speed on the sec-tor, and the more investors involved, the better. So there areno hard and fast rules about how much of an issue we willhold or bid for.

STEPHEN NASH, YOU SAID IFCOVERED BONDS WERE IN A SEPARATE SUB-INDEX IT WOULD BE EASIER TO BUY THEM.� NASH The kind of discussions we have with clients includetalking about the government portfolio, then looking at otherassets with no, or very limited, credit risk – although they havebond-swap risk. So it might be an idea to consider coveredbonds in this context. The splitting of the supra-sovereign

index by UBS at the beginning of 2005 enabled us to showclients an independent view that these bonds, as defined byUBS in its Composite Bond Index, constitute a separate assetclass. It enables the client to say you can invest in govern-ments, or you can invest in supras, or you can invest in a cove-red bond sub-index.� KONG I agree that such a move would make the wording ofmandates a little easier. But I’m not sure you need a separateindex – what would help would be to have a well-identifiedsector called covered bonds, with generally accepted rules interms of what can be included in this sector. We havemandates, for example, which say we can only invest in triple-Asovereign and supranationals, so potentially we could addcovered bonds to these mandates.� CLARK At the moment covered bonds sit within a sector ofthe UBS Credit Index called ‘other asset-backed’. I wouldsuggest that as covered bond issuance grows, we may wellintroduce a separate sector within the credit index, probablycalled ‘covered bonds’. As we did with the supra-sovereignindex we will continue to monitor issuance and take feedbackfrom the market users of the index.� RUSSELL At the moment the covered bond market inAustralia consists entirely of foreign issuers. There are noregulated domestic financial institutions issuing covered bonds.This is because our regulator, the Australian Prudential andRegulation Authority (APRA) will not allow the issuance ofcovered bonds by the financial institutions which it regulates.With a recent reinforcement of that position by APRA, it looksas if in the near future the covered bond market in Australiawill continue to be only foreign issuers – which affects theoverall size of the market.� ASTRIDGE It is an interesting position for the regulator totake – what they are saying is that banks can securitise theirassets, which means take them off the balance sheet, whichmeans the regulator loses total control, as opposed to theEuropean example whereby regulators continue to regulate inthe covered bond market.

There has been a significant amount of work done to tryand convince APRA that covered bonds should be allowed tobe issued by domestic banks. But APRA still holds depositorssacred, and the regulator is unable to engage on there being anyalternative to statutory protection. However, the more foreignissuers come to Australia to issue covered bonds and the morethe market grows, that should increase the pressure on APRAto rethink its position.� TUNESTAM I would assume that APRA would also recognisethat depositors are also usually borrowers, taking up mortgages,and they would be interested in receiving lower mortgage costs.Also, the rating agencies which rate financial institutions on anunsecured basis also recognise that when an issuer has accessto the covered bond market – which is a very deep, liquid andestablished market – it has a positive impact on the unsecuredrating of the financial institution, which should also strengthenthe position of depositors. •

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