Earlier this month, the UK’s Prudential Regulation Authority took an axe to how non-UK covered bonds are considered as High Quality Liquid Assets (HQLA) by UK banks, before U-turning just over a week later.
For now, non-UK covered bonds still qualify for Level 2A HQLA status when bought by UK bank treasuries for their Liquidity Coverage Ratio (LCR) portfolios. But despite reversing its stance just over a week ago, the PRA has said it will revisit its decision in the future, after consulting with the market, of course.
Thankfully, the PRA’s plans did not slam the door shut on the sterling covered market, but it has for sure made the aperture smaller.
Just one week after the PRA backtracked, investors proved eager to pick up sterling exposure, propelling the book on Skipton Building Society’s latest offering to over £1.4bn at its peak.
The UK builder went on to land its £500m January 2030 deal at a spread of 57bp over Sonia, 5bp inside of initial price thoughts. As of Tuesday afternoon, the note was bid tighter at 55.5bp, according to Tradeweb.
Despite Skipton proving investors are hungry for sterling covered debt (even with the regulatory meddling), it should not be taken as a barometer of a post-PRA shenanigans market.
Skipton is, of course, a UK name accessing its home market. And as such its covered bonds, should — barring some almighty and unexpected rule change — be eligible for use as HQLA and not subject to changes in the UK's equivalence regime.
Instead, the real test will come when a non-UK issuer plucks up the courage to tap the sterling market.
Sterling misses
For many large multi-currency non-UK funders, like the Canadians, Aussies or Singaporeans, sterling is a key part of a diverse funding mix, and not one they would like to miss out on.
The currency has in the past proven a fruitful source of funding for non-UK names. Last year, for instance, £7.9bn of the £13.7bn was raised by offshore firms, according to GlobalCapital’s Primary Market Monitor.
And UK names alone cannot fill the gap left in their absence. Of course, most UK funders would rather not put all their eggs in the same funding basket — many depend on the diversity that offshore markets like euros or Swiss francs offer.
Although UK firms scooped £5.8bn out of the euro market last year, they raised a comparable amount in euros: €6bn (£5.1bn), PMM shows. But even if they were to raise all their euro funding at home, they would still fall short of replacing the total including non-UK issuers.
This year to date, only £600m has been placed by offshore firms. And although non-UK borrowers are confident that a deal would still be possible under the PRA’s proposed modified rules, many are not in a rush to test it.
UK bank treasuries make up a small share of sterling covered demand, non-UK issuers told GlobalCapital, purchasing up to 30% of recent issues. But the news around their absence is certain to hit sentiment.
For now, the future of non-UK issuers is uncertain. Until the PRA clarifies its stance, market participants expect UK bank treasury investors and offshore borrowers to remain cautious.
At a sovereign level, the UK is reliant on the “kindness of strangers” — or foreign investors — to fund its large deficit, former Bank of England governor and newly elected Canadian prime minister Mark Carney suggested in 2017.
And although sterling covered bonds are not necessarily in the same place — its foreign issuers are well known to UK investors — the market still depends on these visitors for its critical mass.