Happy birthday, dear Pfandbrief: has this veteran instrument had its day? Guest contribution published in Frankfurter Allgemeine Zeitung
28.08.2019 | Joachim Wuermeling DE
1769 was a bumper year for explorers and inventors. Captain James Cook, sailing on the Endeavour, discovered New Zealand; the compositions of Wolfgang Amadeus Mozart held Italy in thrall; and, on this day exactly 250 years ago, Frederick the Great invented the Pfandbrief, which has become one of the most important debt instruments known to humankind today. That seems reason enough to take some time to reflect on the Pfandbrief’s achievements.
In the generation of Bitcoin, blockchains, crowdfunding and so forth, is there still room for such a traditional financial product? Without a doubt! Especially in times of fundamental upheaval, the reliability and long-term orientation of the Pfandbrief are of inestimable value. Incidentally, Mozart’s compositions are still racking up a high play count on Spotify today, and the island nation of New Zealand is prospering under Queen Elizabeth II.
A short look at its history shall suffice to illustrate the factors that have made the Pfandbrief a success. Following the Seven Years’ War (1756-63), much of the nobility and landowning class was deeply in debt; a veritable credit crunch had arisen. Frederick the Great issued a “Cabinet-Ordre” on 29 August 1769, creating a reliable legal framework by royal decree for wealthy individuals or cities to pledge their possessions as collateral in order to obtain credit. The security the creditors received was twofold: not only was the debtor personally liable to them, but a large number of lands and buildings stood as collateral. The desired result was achieved: the credit crunch was overcome, and long-term investment got the economy back on its feet.
Thus began the Pfandbrief’s global conquest. It spread throughout Germany, Europe and parts beyond. Legal foundations were created, supervisory systems set up, and specialised credit institutions founded. The toolkit was steadily refined and the range of collateral expanded. Pfandbriefe have now evolved into one of the most important refinancing instruments available to banks. As at end-2017, the global volume of covered bonds (the overarching international term, of which Pfandbriefe are a subset) amounted to €2.5 trillion. Germany alone accounted for 15 per cent.
Market participants, lawmakers and regulators have modernised the Pfandbrief time and time again over the course of centuries. However, they all withstood the temptation to water down its founding principles, such as by expanding the scope of application to cover less stable forms of collateral or by diluting the cover pool. Efforts to harmonise the legal framework for covered bonds in the EU have been modelled on the provisions governing, and experiences with, Germany’s Pfandbrief.
This instrument has thus always retained its defining features: creditors receive first-class collateral while borrowers, whether retail or commercial, are enabled by this type of loan to reliably fund their long-term investments at relatively low cost. The Pfandbrief has turned out to be particularly stable in Germany: despite various financial and monetary crises in the past two and a half centuries, to the best of our knowledge no Pfandbrief has ever defaulted in this country.
Even so: In a digital age of global markets and highly complex financial instruments, do we still need the archaic Pfandbrief? My answer is an unequivocal “yes”. Even at 250 years of age, the Pfandbrief has by no means had its day, not even in the light of new market developments such as crypto tokens, high-frequency trading and other new financial technologies. Rather, the challenges facing us, now and in future – chief among them digitalisation, Brexit and the future of the EU financial market, as well as ecological transformation – are opening up new opportunities for the Pfandbrief:
as much as digital financial innovation is forcing the Pfandbrief to adapt, it can, by the same token, promote its spread. For instance, digitally converting the Pfandbrief into an electronically transferable token would take its fungibility to an altogether new level. The introduction of an electronic debt security, for which legislation is now emerging, could represent another milestone.
If and when the United Kingdom does exit the EU – regrettable as that would be – the Pfandbrief could have a positive impact, for the continent’s capital markets will have to become even more closely interlinked post-Brexit in order to be able to fund Europe’s economies without the help of the City of London. The EU will also need to diversify its risks more broadly across national borders. In addition, excess savings deposits from Germany would need someplace else to flow.
The EU framework for covered bonds thus not only represents a key building block for completing the capital markets union, but also constitutes an excellent springboard for cross-border investment in Pfandbriefe.
Lastly, climate change and the ecological transformation of economies are challenging the entire financial market to fund sustainable transformation. This will open up wholly new areas of potential for the Pfandbrief. Demand from Germany, not to mention from the rest of the world, for investment to limit climate change is massive. The Pfandbrief can make a contribution to mobilising the funds needed. The first “green Pfandbriefe” have already been issued in Germany. Although their volume is still minimal, this only serves to make their growth prospects that much greater.
In the light of these challenges, the task for banking and financial supervisors is now to maintain and enhance the appropriate framework conditions. In international regulation, we have to make sure that due account is taken of the Pfandbrief’s unique properties. We must be unyielding in our demands that the Pfandbrief’s high standards be upheld. Yet at the same time, we must pave the way for those innovations necessary to future-proof the Pfandbrief.
The fact is, the Pfandbrief has already survived for generations. The jury is still out, as they say, on whether or not it will live in perpetuity – but, at all events, the Pfandbrief’s 250-year history gives it just as rosy an outlook for the future as that of the Windsors in New Zealand and Mozart beyond the Alps.
So, on that note: Happy birthday to the Pfandbrief – long may it live!