Association of Danish Mortgage Banks annual report

Transcription

1 Association of Danish Mortgage Banks annual report

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3 Contents Profile of the Association of Danish Mortgage Banks 04 Chairman s statement 05 Fighting for Danish covered bonds 06 Act addressing refinancing risk 08 Supervisory diamond for the mortgage sector 11 Challenges in rural districts 13 Implementation of CRD IV/CRR and SIFI rules in Denmark 15 EU framework for covered bonds 18 Mobility in the mortgage market 20 Banking union and Danish mortgage lending 22 Report from Rangvid Committee 24 Risk labelling of home loans 25 New EU rules for the protection of consumers raising home loans 26 New key information sheets for cooperative housing sales 28 Lending activity 29 Property market 30 3 The data material used in this Annual Report was updated on 8 August 2014

4 Profile of the Association of Danish Mortgage Banks The Association of Danish Mortgage Banks solely represents financial undertakings which are subject to Danish legislation and supervision and which use funding sources such as Danish mortgage covered bonds ( Særligt Dækkede Obligationer SDOs, Særligt Dækkede RealkreditObligationer SDROs, and RealkreditObligationer ROs) to grant loans against mortgages on real estate. As at 1 January 2014, the members of the Association are: BRFkredit a/s, DLR Kredit A/S, Nykredit Realkredit A/S and Totalkredit A/S. The members of the Association represent nearly 57% of the total bond debt outstanding in Danish kroner (end- 2013). On behalf of our members, the Association strives to gain: Influence on the preparation and interpretation of legislation in Denmark and the EU to promote the interests and market position of the Danish mortgage industry, including as a minimum to ensure a level playing field for the mortgage system A strong voice in the public debate An overview of and insight into trends and changes in international legislation. The Association works to maintain and develop a mortgage system which is characterised by a strict balance principle and transparency of prices and products, and which offers a flexible and market-based prepayment system. It is our firm belief that the Danish mortgage model provides: Low and competitive prices of loans backed by mortgages on real estate Transparency of loan rates and prepayment terms Accessible financing for all people owning real estate Financial stability. 4

5 Chairman s statement The Danish mortgage model offers one of the best, cheapest and most robust ways in the world to finance residential and commercial properties. For more than two centuries, it has ensured the availability of affordable housing for Danes and has played a key role for growth and employment in Denmark. Today, six years after the financial crisis, regulation of the financial sector is still high on the political agenda in Denmark as well as abroad. We welcome regulation if it contributes to ensuring the requisite resilience. The mortgage sector is not a shrinking violet that wants to hide in the shadows. On the contrary. We are an integral part of Danish society, an important element of the Danish economy, and we consider it natural for the Danish mortgage sector to be in constant dialogue with the surrounding world. But for the time being, the challenge is that part of the regulation especially the international could potentially create new problems. For instance if the nature of the Danish mortgage model is not fully appreciated, or if regulation places mortgage finance at a competitive disadvantage compared with other sources of funding, including Danish and foreign banks. That would have far-reaching consequences for the way in which we finance housing in Denmark. It would make it more expensive for Danish homeowners and businesses, while weakening the Danish economy. Therefore, a level playing field for mortgage banks is a key issue to the Association these years and much is at stake. Most recently, the Danish Financial Supervisory Authority has presented its proposal for a supervisory diamond for the mortgage sector. It is about creating financial stability an objective that we fully support. But if we lay down rules for home financing which only apply to mortgage lenders, we will not achieve the socio-economic gains that are the objective. If the regulation only extends to the mortgage sector, there is a risk that Danes switch to alternative funding sources, such as domestic or foreign banks or, even worse, the grey lending market. At the same time, it will become more expensive for borrowers, as mortgage loans are cheaper than all other types of home financing. The Danish mortgage system is stable and robust, and it has proved efficient during both upturns and downturns in the Danish economy. Where other financing sources dried up during the financial crisis, the mortgage sector passed the ultimate stress test and was able to continue to sell bonds and raise funding for lending to homeowners and Danish businesses. Since September 2008, total mortgage lending to Danish households and businesses has grown by over DKK 400bn, while bank lending has dropped by more than DKK 300bn over the same period. So there is every reason to protect our model. We would therefore encourage all stakeholders to consider, when discussing measures, adjustments and legislation, whether the initiative concerned implies a real improvement of the mortgage system or if we actually harm it, contrary to the intention. As a necessary precondition, the mortgage sector should be on an equal footing with other financing sources in terms of competitiveness. Only that way do we ensure that our excellent system is not diluted and that homeowners and businesses are not forced to switch to alternative solutions that are more expensive, more unstable and detrimental to growth and employment in Denmark. 5

6 Fighting for Danish covered bonds Through a concerted effort by Danish MEPs, the government, parliament, the authorities and the Danish financial sector, Denmark has tried over the past year to make the European Commission disregard the recommendations of the European Banking Authority (EBA) on covered bonds. The recommendations may have serious consequences for the Danish mortgage system. Despite Danish opposition, it was adopted in spring 2013 that the European Commission should lay down the final liquidity coverage requirements (LCR) in a delegated act. The LCR requirements include definitions of the liquidity and security of assets. In this connection, the EBA was charged with conducting an analysis of the liquidity features of different assets. The attraction of Danish covered bonds to investors depends very much on their being recognised as highly liquid and secure. Therefore, it would have serious consequences for the Danish mortgage sector if the European Commission were to decide not to classify Danish covered bonds as Level 1 assets ie extremely high quality liquid assets (HQLA). The EBA s report on the liquidity features of assets was published in late The report showed as expected that Danish covered bonds are among the most liquid assets. However, the EBA s Board of Supervisors, made up of the heads of the EU national financial supervisory authorities, recommended that the Commission disregard the report and classify covered bonds as less liquid. This recommendation was a problem for the Danish mortgage system and in practice also ignored the provision of the capital requirement rules (CRD IV/CRR) stating that assets should be assessed on the basis of objective criteria. Also, the statement of intent to the effect that the most liquid covered bonds should qualify as Level 1 assets was set aside. A statement which Danish Members of the European Parliament had worked hard to have inserted. CONCERTED DANISH EFFORT In light of the surprising announcement that the EBA would recommend that only government bonds be classified as Level 1 assets, an intensified Danish effort was needed. The Danish parliament, government and ministries, Danish MEPs, Danmarks Nationalbank, the Danish FSA, the Permanent Representation of Denmark in Brussels and the financial organisations began a huge effort to have Danish covered bonds recognised for their excellent security and liquidity. The effort has included numerous enquiries and delegations to the European Commission and winning support for the Danish cause in a number of capitals in the EU. The effort also included cooperation with various international bodies and financial organisations in other countries. The Association is pleased with the generally high priority given to this cause and the considerable resources spent. The European Commission is expected to submit its proposal for the future liquidity requirements in the autumn of Even though we do not know the details of the proposal, yet there is every indication that the intensified Danish effort has paid off. Thus, we expect that the proposal will recognise Danish covered bonds as belonging to the category of extremely HQLA and that the final solution will to a wide extent take account of the Danish mortgage model. 6

7 From CRR to final LCR requirements for Danish covered bonds 7 The implementation of the new LCR requirements implies that all assets will be classified on the basis of their liquidity and security. Today, Danish covered bonds are traded and used as assets of very high liquidity and security. It is therefore crucial that they are also classified as such (as Level 1 assets) under the LCR. The determination process for the LCR requirements for covered bonds is outlined below. CURRENT RULES (UNTIL 1 JANUARY 2015) No current EU requirement of compliance with a specified liquidity buffer. In other words, Danish covered bonds are not subject to any volume restrictions or haircuts relating to a liquidity buffer. JUNE CRD IV/CRR Covered bonds are not explicitly classified in the CRR as is the case with government bonds. The European Commission is mandated to classify the assets on the basis of recommendations from the EBA and to lay down additional requirements, such as caps on holdings and haircuts, for the individual liquidity classes. DECEMBER RECOMMENDATIONS FOR EUROPEAN COMMISSION S DELEGATED ACT In its Report on appropriate uniform definitions of extremely high quality liquid assets (extremely HQLA) and high quality liquid assets (HQLA) and on operational requirements for liquid assets under Article 509(3) and (5) CRR, the EBA recommended that covered bonds (including Danish covered bonds) be classified as Level 2A assets. That would probably have meant that Danish covered bonds could only make up 40% of the liquidity buffer and should be subject to a haircut of at least 15%. AUTUMN PROPOSAL FOR EUROPEAN COMMISSION S DELEGATED ACT The Council and the European Parliament may reject the delegated act within a specified time limit. Otherwise the delegated act will be binding. If the delegated act is rejected, the European Commission will have to draft a new proposal for a delegated act to be submitted to the Council and the European Parliament.

8 Act addressing refinancing risk The new Danish act addressing refinancing risk provides clarity for borrowers, investors, mortgage lenders and banks in an extreme crisis where a mortgage or commercial bank is unable to complete the refinancing of matured SDO bonds on market terms, or if interest rates rise steeply. The Association of Danish Mortgage Banks will monitor closely that the act does not distort competition between commercial banks and mortgage banks. OUTLINE OF THE ACT The act applies to covered bonds (SDROs, SDOs and ROs) issued by mortgage banks and commercial banks where the loan term is longer than the maturity of the bonds funding the loan. An example is a 30-year mortgage loan subject to annual interest rate adjustment, ie that the loan is funded through the issuance of 1-year bonds once a year. The background for the act is set out in detail in the fact box. The act entered into force on 1 April 2014 for bonds with an original maturity of up to and including 12 months. For bonds with maturities over 12 months, the act will enter into force on 1 January The act introduces two triggers of extension of bond maturity: Refinancing trigger: If a mortgage bank is unable to sell the bonds offered before the maturing bonds mature, the refinancing is considered to have failed. In this situation, the maturity of the maturing bonds will be extended by 1 year at a time until there are takers for all the necessary bonds. Maturity extension for 1 year at a time is also required for mortgage banks or commercial banks in liquidation. Interest rate trigger: If the sale by auction of new bonds with maturities of up to and including 24 months results in a yield-to-maturity higher than the yield-to-maturity of corresponding bonds a year earlier plus 5 percentage points, the maturity of the maturing bonds will be extended by 1 year. Extension as a result of the interest rate trigger can only be applied upon ordinary maturity of bonds. For variable-rate bonds, the regular interest rate fixing is also subject to a cap on interest rate rises in the form of locking-in of the interest rate for 1 year or until the next refinancing. The coupon rate of the extended bonds is fixed at the yield-to-maturity of corresponding bonds a year earlier plus 5 percentage points. For variable-rate bonds, the coupon is fixed at the interest rate applied at the latest interest rate fixing plus 5 percentage points. ENSURING A LEVEL PLAYING FIELD In connection with the new act, the Association has considered it important that the conditions are the same for banks that fund loans by issuing own SDOs and on the other hand banks that fund loans through a joint funding structure with a mortgage bank, or mortgage banks that fund loans by issuing SDROs, SDOs or ROs. During the reading of the proposal, we were pleased to note that efforts were made to ensure a level playing field. On one point, however, commercial banks and mortgage banks are not treated equally. There is no requirement of maturity extension of bonds issued by commercial banks. Extension only applies in a liquidation scenario. The systemic risk addressed by the act in respect of mort- 8

9 Figure 1: Treatment of individual loan types Interest rate trigger Refinancing trigger Effective from Loans with 1-year funding 1-year yield Yes 1 April 2014 Loans with 2-year funding 2-year yield Yes 1 January 2015 Note: The act does not apply to loans funded by bonds with the same maturity as the loan, such as 30-year fixed-rate callable loans. Cibor/Cita/Euribor< 2-year Interest rate cap Yes 1 January 2015 Cibor/Cita/Euribor > 2-year No Yes 1 January 2015 Loans with > 2-year funding No Yes 1 January 2015 gage banks remains unchanged for SDOs issued by commercial banks. It cannot be excluded that such differential treatment may affect the pricing of the bonds to the disadvantage of borrowers. Hence, there is a risk that an inexpensive mortgage model is replaced by a model in which the systemic risk remains unchanged for banks (government guarantee implied) and the Danish financing system trends towards a system with higher prices for some borrowers and increased fluctuations in lending. Bank lending grew by nearly DKK 650bn between 2004 and 2009 (up approx 120%) and subsequently contracted by over DKK 300bn between 2009 and 2013 (down approx 25%). In the same period, mortgage lending grew steadily by about DKK 1,000bn between 2004 and 2013 (up approx 75%). We will monitor whether this differential treatment will distort competition between commercial banks and mortgage banks. We will do so partly through a working group under the ambit of the Ministry of Business and Growth, which will monitor whether the act leads to changed competitive conditions for commercial and mortgage banks. The working group will also monitor whether the new legislation fosters business models that are not resilient to stress scenarios. The working group will submit its first re- Background With the popularity of mortgage loans the term of which is longer than the maturity of the bonds funding the loan (non-prefunded loans), the Danish mortgage system is facing refinancing risk. The reason is that the mortgage banks have to sell new bonds regularly to fund existing loans. A working group set up in autumn 2013 with participants from the Danish Ministry of Business and Growth, Danmarks Nationalbank and others considered the management of refinancing risk. On that basis, the government submitted a proposal in November 2013 introducing contingent maturity extension for covered bonds with maturities shorter than the terms of the loans they fund. The Danish parliament adopted the bill in March Figure 2: Non-prefunded mortgage loans currently total over DKK 1,800bn 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 3, , , , , % Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan Non-prefunded (under 2 years) Non-prefunded (over 2 years) Prefunded Total outstanding mortgage lending (right axis)

10 port in September 2014, and three years after commencement of the act, an impact assessment will be conducted. FOCUS ON TRANSPARENCY We welcome the initiative launched with the new act to create greater transparency as regards the cost of home loans from commercial and mortgage banks. A public website will be set up that shows the actual annual costs including fees of home loans secured by mortgages on real estate issued by mortgage banks and by commercial banks in the form of secured bank loans. That will clearly illustrate to consumers which is the cheapest home loan. CONTINGENCY MEASURES With the new legislation for managing refinancing risk, contingency measures have been established. The aim is to avoid having to use the contingency measures. In the Danish mortgage market, the sale of bonds for refinancing of loans has never failed. We regard the Danish legislation as an expression of focus on maintaining a Danish mortgage model offering a high degree of security of supply and covered bonds offering a high degree of security. RATING AGENCY S REACTION TO THE ACT In the opinion of the Association, the act is a good initiative towards resolving the refinancing issue in respect of loans with 1-year funding. Unfortunately, credit rating agency Standard & Poor s (S&P) is not firmly convinced that this is the case. S&P acknowledges that the act manages the refinancing risk in a stress scenario, but remains critical of the fact that a stress scenario may nonetheless still occur. Refinancing in practice how a mortgage bank conducts the sale of bonds to be refinanced. The process may vary from one mortgage bank to the next and from one bond to the next. It is customary among mortgage banks to sell the largest ISINs on auction, while the remaining ISINs are sold either at auction or on tap. To fulfil the Liquidity Coverage Ratio (LCR) requirements, most mortgage banks schedule their sales so that all bonds are expected to be sold 30 days before the maturity date of the maturing bonds at the latest. A few weeks before the sale, the mortgage bank informs the market of the amounts offered in the individual ISINs, the scheduled dates of sale and the type of sale (auction, tap sale or otherwise). Before the sale commences, the mortgage bank informs the market of the trigger rates fixed for bonds funding loans subject to refinancing annually or every two years (usually referred to as ARMs with 1-year or 2-year funding). The trigger rate is fixed at the yield-to-maturity (YTM) of corresponding bonds a year earlier plus 500bp. If the sale of new bonds results in a YTM above the trigger rate, the maturity of the maturing bonds is extended by 1 year and the coupon is fixed at the trigger rate. YTM below the trigger rate. If the mortgage bank has a reasonable expectation of selling the bonds at a YTM below the trigger rate, the sale can be executed. If not, the sale must not be executed. If a mortgage bank is unable to sell the bonds offered before the maturing bonds mature, the refinancing is considered to have failed. In that case, the maturity of the maturing bonds will be extended by 1 year and the coupon will be fixed at the trigger rate. Each day of a selling period is settled separately. This means that a sale executed on one day is final and will not be affected by any failure to execute a sale at a later time or by a breach of the trigger rate. For example, if a mortgage bank has sold 80% of its bonds at a YTM below the trigger rate and yields subsequently rise to above the trigger rate and the bond maturity is extended, investors in the maturing bonds will have 80% of their holdings redeemed and 20% extended. A similar method is applied to floating-rate bonds, with the adjustments following from the special characteristics of this type of bond. In the selling period, the mortgage bank must assess before each sale whether the bonds can be sold at a 10

11 Supervisory diamond for the mortgage sector The idea of a supervisory diamond for mortgage banks was introduced in the Rangvid report prepared by the Committee investigating the causes and consequences of the financial crisis in Denmark. The Danish Financial Supervisory Authority recently presented its proposal, which is well in line with the adjustments currently undertaken by mortgage banks. We welcome the focus on a level playing field for mortgage banks and commercial banks created by the supervisory diamond. 11 A supervisory diamond is a well-known concept in the Danish financial sector where it was introduced for banks in A supervisory diamond is based on quarterly reports submitted by the institutions to the Danish FSA. The values reported are compared with a number of predefined limit values for five selected indicators. If the limit values are breached, the Danish FSA opens a dialogue with the institution concerned. Upon individual and concrete assessment, the Danish FSA may take action, for instance in the form of increased supervision, risk disclosure requirements or orders. In September 2013, the Committee investigating the causes and consequences of the financial crisis published its report, which contained a number of recommendations for the government. One of the recommendations in the report was about a supervisory diamond aimed a mortgage banks. The recommendation is based on the opinion that it is important to set out indicators that reflect the risks of mortgage banks, for example the share of mortgage loans subject to refinancing more frequently than every two years as well as limits to the share of interest-only (IO) loans. In September 2014, the Danish FSA issued a consultation paper on a supervisory diamond for mortgage banks. The supervisory diamond will contain the following indicators: 1) Lending growth 2) Borrower s interest rate risk 3) Interest-only loans 4) Loans with short-term funding 5) Concentration risk The indicators provide some general limits, for instance to the level of lending growth within a year. The indicators will be phased in and take effect from 2018, but not until 2020 as regards interest-only loans and loans with shortterm funding. This means that the mortgage banks will typically be outside the limits to begin with. The idea is that they will reach the targets of the supervisory diamond gradually towards The reason for such phasing in is that mortgage loans are long-term loans. Thus, mortgage banks cannot implement changes in the very near term. Changes only occur when Danish borrowers refinance, remortgage or raise new loans. Consequently, adaptation to the supervisory diamond will take time. For more details on the supervisory diamond and the individual indicators for mortgage banks, please refer to the website of the Danish FSA. The Association of Danish Mortgage Banks supports the objective of safeguarding financial stability using a supervisory diamond. The indicators are well in line with the adjustments already being made by mortgage banks, for instance through new loans with longer interest reset periods, changed administration margins, etc.

12 Furthermore, we welcome the focus on a level playing field for all mortgage banks as well as between mortgage banks and commercial banks created by the supervisory diamond. If you want to mitigate the financial risk in society, the requirements for lending by mortgage banks and commercial banks should be the same. The supervisory diamond proposal has been submitted for public consultation until 8 October During the consultation period, the Association will examine the proposal in detail, but generally it appears to be a good proposal, which we support. 12

13 Challenges in rural districts Loss of jobs, depopulation and large distances between public services are some of the challenges which some of our rural districts are struggling with and which many people are concerned with. Among the consequences of this trend are oversupply of dwellings and falling property prices. In this connection, mortgage banks are sometimes encouraged to relax their lending policies. But that is not the solution. The reason is the urbanisation that has taken place for the past years with more and more people moving from rural districts to towns and cities. Therefore, an extensive and broad-based debate is needed about whether we want this trend to continue, about possible alternatives and about what those alternatives would require more generally. 13 Mortgage banks are prepared to provide the lending if borrowers can provide security for the loans. That is what they do. There are no dark spots on the map loans are granted in all parts of Denmark. Whether we look at peripheral, rural or urban municipalities, there is not much difference in lending activity. Nor is there a fixed minimum limit to the loan amount. In other words, new loans below DKK 500,000 are granted, and there is not much variation across municipalities. But examples do exist of loan applications that have been refused by a mortgage bank. But even if this is no consolation to those who have been refused, examples are few compared with all the homeowners and businesses whose loan applications have been granted. Over the past five years, the mortgage sector has increased its lending by over DKK 400bn, and the increase is distributed evenly across Denmark. In the same period, banks lending declined by more than DKK 300bn. Thus, Danish mortgage banks have played a huge role in ensuring financing for homeowners and businesses during the crisis, also in rural districts. The Danish mortgage model has ensured the provision of good and affordable loans to homeowners and businesses for more than 200 years. It is therefore crucial for the sector that the security of the Danish mortgage model is not jeopardised in an effort to solve the problems in rural districts. Then investors would not pay the good price for the bonds ensuring the low loan rates for homeowners and businesses. That would destroy the mortgage system and lead to higher prices for all borrowers. And that would not solve the problems in rural districts on the contrary. A decisive factor for people to stay in rural districts, and for young people to move back when they have graduated, is jobs. According to a survey by the Association of Danish Mortgage Banks together with Epinion, a market research company, job creation in the peripheral areas is important if people are to return. Among young people, education is the main reason why they move and they increasingly settle down in towns and cities. Over time, today s young people will become even more important to the future of the peripheral areas. They are the coming homebuyers and can create migration to and increase activity in these areas. We are up against strong forces. The Danish retail trade is in a transition phase, and public administration and services are also being centralised, cf municipal reforms and the new hospital structure. Mortgage banks provide loans for up to 30 years, and the margins are very small. The mortgage system does not have the capacity to withstand an inevitable development. One major challenge is that there are far more properties than buyers in some rural districts. On top of that, some properties are in such poor repair that they drag down the value of neighbouring properties in good repair, and then these properties become difficult to sell as well. Therefore,

14 the Association finds that it would make sense to tear down certain properties in these areas. The government has earmarked DKK 200m for renovation and demolition of dilapidated housing in 2014 and This is a good initiative, but far from sufficient. According to a report by the Danish Building Research Institute (SBI) published at the beginning of 2014, the number of properties that should be demolished is estimated at 50,000-60,000. According to the SBI, the estimated cost is DKK 5bn-6bn. In other words, the funds set aside by the government far from match the magnitude of the problem. In a report by the Danish Town Planning Institute ( Vejkantsdanmarks fremtid ), the Institute recommends tearing down a number of Danish villages or part of them which are in such poor repair that the residents are unable to sell their houses and are bound to the land. This is no easy decision, but in our opinion it makes sense to think along those lines. The Ministry of Housing, Urban and Rural Affairs has set aside DKK 30m for urban renewal. The funds will be used for projects to boost the local environment in troubled town centres, create shopping streets in small and large towns and strategic shrinking of the smallest towns. But the funds set aside for these purposes should preferably be more long-term and permanent. It is an ongoing task of the local authorities to clear up their housing stock as residents move out or want to move out. But local authority decisions take time and require consultation processes etc. Therefore, it would be better if the local authorities were able to plan for a longer time horizon. The Association of Danish Mortgage Banks would be pleased to take part in the dialogue with different stakeholders, not least the local authorities, about finding individual, flexible solutions to specific problems just as we are doing today in some cases. A regular clear-up of the housing stock would provide a better balance between supply and demand in the housing market, thus boosting the value of the remaining properties. That would improve borrowers opportunities for raising loans also mortgage loans. Figure 3: What could make you move back to the municipality you lived in before you moved to your current municipality of residence? If I am offered a job My friends/family/spouse A cheap dwelling Nothing could make me move back If I can borrow the money to buy a home Other Source: Association of Danish Mortgage Banks, Epinion All Don t know year-olds 0 10% 20% 30% 40% 50% 60% 70% 14

15 Implementation of CRD IV/ CRR and SIFI rules in Denmark The new legal framework for carrying on commercial and mortgage banking in Denmark fell into place in spring The Capital Requirements Directive (CRD IV) was implemented in Danish law through an act amending the Danish Financial Business Act. The Capital Requirements Regulation (CRR) is directly applicable to Danish commercial and mortgage banks, and new regulation of systemically important financial institutions (SIFIs) has been adopted. A comprehensive legal framework, which is very resource- and time-consuming for the institutions to adapt to. 15 OVERVIEW OF IMPLEMENTATION OF NEW EU RULES Together, the CRD IV and the CRR will make up the legal framework in the EU for carrying on commercial and mortgage banking. The aim of the new rules is to strengthen the resilience of the financial sector in the EU. CRD IV was implemented in Danish law through an act amending the Danish Financial Business Act which entered into force on 31 March 2014, while the CRR became effective on 1 January In some areas, the rules will be phased in over a number of years. The new rules will be supplemented by additional EU rules so-called Level 2 regulation. The supplementary legislation may be in the form of both directives and regulations. To the extent such supplementary rules require adaptation of the Danish rules, this will be addressed and determined politically. In this connection it is essential to retain political influence in the legal drafting process. The elements of the new regulation which may pose a challenge to mortgage banks are discussed below. CAPITAL AND CAPITAL REQUIREMENTS The required level and quality of the capitalisation of banks and mortgage lenders will increase considerably with the introduction of the new capital requirement rules. New capital buffer requirements have been introduced: a capital conservation buffer and a countercyclical capital buffer. The latter is a buffer aimed at strengthening the resilience to economic trends. The purpose of the buffers is to make financial institutions build up reserves. The countercyclical capital buffer comes on top of the capital conservation buffer and will vary between 0% and 2.5% of risk-weighted assets depending on the economic climate. In addition comes a requirement of a systemic risk buffer of up to 3%. Overall, the new rules mean that mortgage banks equity requirement rises from the current 2% to 12.5%, and the total capital requirement increases from 8% to 14%. The tighter requirements for the level and quality of capitalisation will be phased in by Also, mortgage banks may have to comply with a capital adequacy requirement specified by the national supervisory authority, and in addition the mortgage bank itself may require a certain reserve buffer. These are requirements that will be added to the total capital requirement of 14%. To comply with the coming capital requirements, mortgage banks will have to improve their capitalisation over the next few years. We find it positive that a new instrument has been provided in the form of non-voting shares for raising capital for converted mortgage banks previously wholly-owned by associations and funds. However, the initiative in the form of non-voting shares will hardly be enough. The institutions will probably need to increase their income to generate the requisite capital;

16 issuance of non-voting shares also involves paying dividends to the new shareholders. The higher administration margins already introduced should also be seen in light of the need for new capital. The new capital requirements will affect all financial undertakings in the EU. So even though administration margins have been raised, it does not change the fact that the Danish mortgage system is one of the cheapest in the world probably the cheapest. LIQUIDITY The new short-term liquidity requirement (LCR) will be fully phased in from It is a material precondition that Danish covered bonds are sufficiently eligible for inclusion in the stock of liquid assets under the LCR. For more details on the classification of liquid assets, please refer to Fighting for Danish covered bonds. Detailed requirements for stable funding await EU rules in this field. The Association of Danish Mortgage Banks assumes that, when the time comes, the Danish authorities will obtain approval of the new Danish solution to managing refinancing risk in relation to the coming EU standards. MACROPRUDENTIAL TOOLS The Minister for Business and Growth has been authorised to apply so-called macroprudential tools to mitigate systemic risk. They could be in the form of higher risk weights to handle asset price bubbles in the residential and commercial property sectors and thereby higher capital requirements for lending in these sectors. A higher risk weight on a residential mortgage loan would be an extra cost to a mortgage bank. The higher costs would render it more expensive to borrow. Therefore, such tools should be used with caution. CORPORATE GOVERNANCE The new capital requirement rules from the EU include important requirements for the management of credit institutions. For systemically important financial institutions (SIFIs), limits have been set to the number of posts on boards of directors and executive boards. A member of the board of directors of a SIFI may sit on one executive board and two boards of directors, or alternatively on four boards of directors. Derogations from this rule have been laid down for posts in undertakings not primarily engaged in commercial activities, where the board member has been appointed by the government, etc. Furthermore, the Danish FSA may grant permission for one additional directorship if deemed reasonable as regards the work load, or allow that a directorship is not included in case of a modest work load. Regardless of the possible derogations in special cases, it is clear that financial undertakings including mortgage banks are subject to stricter requirements than other undertakings. This implies the risk that mortgage banks will find it harder to attract qualified candidates for their boards. This is in conflict with the purpose of the rules to ensure better management. The Association therefore calls for a flexible approach in applying the rules in order to ensure the right skills for the institutions managements. REGULATION OF SIFIS The Association of Danish Mortgage Banks is satisfied with the fact that all major Danish mortgage banks have been designated as SIFIs. It is essential that none of the major mortgage banks have not been designated as SIFIs, as problems for one mortgage bank may affect the confidence in the entire Danish mortgage system. The SIFI rules enter into force on 1 January

17 On a number of points, requirements are stricter for SIFIs than for non-sifis, including for example a capital requirement in the form of a SIFI buffer, cf above. The overall aim of the requirements is to ensure that SIFIs are sufficiently robust. But Denmark does not have to be a frontrunner in the EU, which would have been the case if a crisis management buffer had been introduced today together with the SIFI rules. ADMINISTRATIVE BURDENS The legal framework includes a wide range of corporate governance requirements for financial undertakings. They include the setting up of nomination and risk committees, whistleblower schemes and preparation of recovery plans. All in all, highly resource- and time-consuming tasks. Both the Danish FSA and the European Commission are preparing estimates of the administrative burdens associated with the various new initiatives. These estimates strongly undershoot reality. A relationship of 1:10 between estimates and actual numbers is not uncommon. The total costs of establishing the new reporting systems are also substantial. In our view, the authorities calculations of the administrative burdens on the business sector are not a fair estimate of the actual impact of the set of rules. Therefore, they should consider changing the determination method so as to reflect reality. At the same time, attention should be had to any unnecessary burden on businesses caused by the new rules, and whether less resource- and time-consuming solutions could be used, when drafting the rules. 17

18 EU framework for covered bonds The European Commission is considering examining the possibility of introducing an EU legal framework for covered bonds. We are generally positive towards the Commission s intention, but it is important to bear in mind that an attempt to harmonise the different national covered bond regimes will involve huge challenges. Regulation should be in the form of a directive with minimum requirements so as to accommodate different business models. LONG-TERM FINANCING In late March 2014, the European Commission issued a communication on long-term financing of the European economy. The communication contains some initiatives that follow up on the challenges of long-term financing of growth in the European economy. And in this context, covered bonds are mentioned as an area that may be included in a future financing policy for the EU. The European Banking Authority (EBA) has examined whether the lower risk weighting, and thus the lower capital requirement, relating to covered bonds compared with other bonds is still justified. Moreover, the EBA has identified best practices in relation to covered bonds in different countries. The results of this work are contained in a report published by the EBA in July IDENTIFICATION OF BEST PRACTICES At the request of the European Systemic Risk Board (ESRB), the EBA has prepared an opinion on best practices in relation to covered bond legislation. In a number of areas, recommendations for best practices have been made see the fact box. The recommendations are aimed at national supervisory authorities for incorporation into national legislation. CAPITAL REQUIREMENTS FOR COVERED BONDS The EBA has examined the risk weighting of covered bonds and thus whether the lower capital requirements compared with other bonds are justified. The EBA has submitted its opinion to the Commission together with its recommendations for best practices. The EBA finds that the lower risk weighting of covered bonds can be maintained. It is recommended to increase the security of covered bonds by requirements regarding overcollateralisation (OC requirement), liquidity buffer, duties and powers of supervisory authority and disclosure. Some of the recommendations are highly relevant, whereas others are less expedient, including the OC requirement. The reason is that credit rating agencies require high OC for bonds with high credit risk, eg bonds issued in countries with weakly regulated mortgage systems. Thus, high OC is not necessarily a sign of high quality. MORE EUROPEAN REGULATION With the EBA s report on covered bonds, the European Commission has obtained input for its further deliberations on the introduction of an EU framework for covered bonds. We are generally positive towards the Commission s intention, but it is important to bear in mind that harmonisation of the different national covered bond regimes will involve huge challenges. In connection with the adoption of financial legislation in the EU after the financial crisis, there have been several examples of situations where the Danish mortgage system 18

19 has been under pressure. This is due to the fact that the legislation was made on the basis of a traditional banking model and not a specialised banking model such as the Danish mortgage model even though it demonstrated its strength during the financial crisis. On the one hand, the Commission s initiative may be seen as a good opportunity to have the characteristics of a strong mortgage system described and laid down by law. On the other hand, such initiatives invariably involve the risk that small countries are bulldozed. We will join the work of examining the basis for a legal framework proactively, but also critically. In this process, it is important to keep in mind that overly detailed rules could render it difficult to maintain an effective system such as the Danish one, whereas a more watered-down model would entail a risk of insufficient security behind covered bonds. Reduced confidence in covered bonds may lead to higher prices. The general key elements which, in our opinion, should be included in an EU legal framework for covered bonds are: The assets behind the bonds must offer real security. The collateral must have a stable value equivalent to the value of loans secured by mortgage on real estate. Also, there must be transparency as to/requirements for the disclosure of the assets behind the loans. It would be inexpedient to lay down statutory requirements for the distribution between loans secured by mortgage on residential properties and commercial properties, respectively, in the cover pool. National supervision of covered bond issuers. An effective possibility to enforce the security in case of default with a view to ensuring the function of the mortgaged property as security for the loan. In the further deliberations, it is important to ensure that effective existing systems such as the Danish one are not adversely affected by increased harmonisation. A common set of rules must be able to accommodate different business models. Regulation should therefore be in the form of a directive stipulating minimum requirements. The EBA s recommendations for best practices 19 A priority claim on specific assets for covered bond investors (dual recourse) Segregation of cover assets and no acceleration upon issuer s default (bankruptcy remoteness) as well as requirements for administration of cover pool upon issuer s default Requirements for collateral (assets) in the cover pool (composition and geographical location of assets) Valuation of property and frequency thereof as well as LTV limits Coverage principles and minimum overcollateralisation (OC requirement) Requirements for management of assets and liabilities risks (use of derivative contracts for risk hedging purposes, liquidity buffer, stress testing) Supervision of issuer, appointment of cover pool monitor and detailed description of duties and powers of supervisory authority in the event of issuer default Requirements for disclosure of cover pool data (scope and frequency)

20 Mobility in the mortgage market A report from the Danish Ministry of Business and Growth concludes that no special fees are charged in connection with a change of mortgage banks. It is important to competition in the mortgage market that consumers do not face any unnecessary barriers when they want to change mortgage banks. The report will be followed by initiatives to increase mortgage market transparency. For instance, a price comparison tool will be established, showing the effective prices of home loans offered by banks and mortgage lenders. The Association of Danish Mortgage Banks will support any proposal to increase mortgage market transparency. In June 2014, a working group on competition in the mortgage market set up by the Danish Ministry of Business and Growth submitted its report on barriers to consumer mobility in the mortgage market. The working group was looking at consumers possibility to change mortgage banks and the costs involved. The report concludes that the costs of changing mortgage banks are equal to the costs of remortgaging within the same mortgage bank. If a borrower wants to change mortgage banks, the only costs will be those associated with the loan and those of remortmaging. The report includes six recommendations with the purpose of enhancing competition, increasing transparency and making it easier for consumers to obtain an overall view of the costs of changing mortgage banks. 1. PRICE COMPARISON TOOL The working group recommends the establishment of a price comparison tool that shows the effective prices of home loans offered by banks and mortgage lenders and thus makes it easier for consumers to compare prices across credit institutions. The mortgage sector already offers a price guide that provides a general view of various administration margins and fees across mortgage banks and makes it easy to compare the products. The proposed tool would enable consumers to compare home loans from banks as well as mortgage lenders and would be welcomed by the Association. 2. DISCLOSURE OF ADMINISTRATION MARGINS AND FEES The working group recommends the preparation of rules on how mortgage banks display their administration margins and fees. For instance, it is proposed that the banks disclose not only the size of administration margins etc but also how they are calculated, and that they group fees according to the stage in the loan process at which they are charged. The Association supports the aim of transparency, but would prefer to focus on developing a good price comparison tool rather than new disclosure rules. 3. COMMON PRINCIPLES FOR LOAN DOCUMENTS Borrowers have to read and understand a great deal of information when applying for a mortgage loan, and the loan documents vary from bank to bank. The working group therefore recommends looking at the possibility to lay down common principles for the preparation of loan documents. The purpose is to make it easier for consumers to understand the documents and compare prices in connection with offers from different banks. 20

21 Obviously, the mortgage banks want to make it as easy as possible for borrowers to obtain information, and they are constantly working to improve availability. We will work constructively with the working group s proposals. But it is no easy task, as the large amount of information is a result of regulatory requirements, including from the EU, introduced for the protection of consumers. 4. CLARIFICATION OF RULES FOR NOTIFYING FEE OR MARGIN CHANGES The working group recommends that changes to administration margins or fees included in the loan agreement be notified individually and at three months notice. However, commercial banks may notify such changes at one month s notice, and this discrimination does not seem to be justified. 5. CLARIFICATION OF RULES FOR FEE AND MARGIN CHANGES The working group recommends that terms regarding changes to fees and administration margins be clearly emphasised in the loan agreement that examples be prepared showing which reasons are deemed to be random and consequently unacceptable that an obligation be imposed on banks to explain to consumers the reasons for any changes to fees and administration margins. We are prepared to look into the possibilities of providing mortgage bank customers with even clearer information about any changes to fees and administration margins than they are given today. Also, we are pleased to note that the working group recognises the need to maintain mortgage bank flexibility in terms of the ability to adjust prices over time. Mortgage banks typically enter into 30-year contracts. It is impossible to predict everything that could happen over a 30-year period, and mortgage banks ability to adjust their prices during the contract period is therefore essential to ensuring a viable business. 6. EXAMINATION OF PRICE SPREADS The working group recommends that the Danish FSA look into the way mortgage banks communicate price spreads. Price spreads may represent a cost of selling bonds. The Association would be pleased to contribute to an examination of how mortgage banks communicate price spreads. 21