NZ fixed income investors could have access to a new $20 billion plus asset class as early as the end of this year if proposed Reserve Bank rules come into force.
Vicky Hyde-Smith, AMP Capital NZ head of fixed income, said the Reserve Bank of New Zealand (RBNZ) ‘residential mortgage obligation’ (RMO) proposals – released last November – could open up substantial investment opportunities for investors if implemented well.
“There’s a big market in Australia for residential mortgage-backed securities,” Hyde-Smith said. “It would be good if we got something like that here.”
Under the proposals the current load of residential mortgage-backed securities (RMBS) held internally by NZ banks as RBNZ trading collateral would be restructured as open-market instruments.
According to the RBNZ consultation paper, internal RMBS (I-RMBS) account for about $23 billion – by far the largest bank asset used to source liquidity from the central bank.
The proposed reforms, tabled by the RBNZ to help manage systemic liquidity in the event of another financial crisis and protect its own balance sheet, would incentivise banks to offload I-RMBS – essentially a ‘free’ source of regulatory capital – as on-market securities.
“In particular, the ability of banks to hold non-marketable I-RMBS as liquid assets reduces the incentive for banks to develop truly liquid securities or acquire other types of liquid assets,” the RBNZ consultation paper says. “For example, if I-RMBS were phased out as eligible collateral and no longer counted as a liquid asset for prudential liquidity purposes, banks might have to develop mortgage bonds that were marketable or hold alternative government guaranteed bonds as liquidity assets.”
The preferred RBNZ model would see the creation of an RMO market based on four guiding principles: quality; liquidity; scalability; and, the need for securities to be non-distortionary.
Hyde-Smith said the viability of an RMO market would hinge on the details – with the major sticking point likely to centre on the quality of underlying mortgages allowed in the securities and how those are managed over time.
“The question now is how that would work in practice,” she said.
The RBNZ is considering answers to that question now after closing off consultation last month: a final draft proposal could be ready for implementation by the end of this year.
“Besides being a funding and liquidity management instrument for lenders, mortgage bonds can be an important and attractive asset class for managed funds and institutional investors,” the RBNZ paper says. “These market participants manage large pools of funds from household savings, insurance premiums and the like. They need to look for liquid instruments to invest in as part of their liquidity management. In many countries, a substantial part of investments is also directed to longer term mortgage bonds as part of the portfolio management strategy. “
Hyde-Smith said RMOs could be attractive to a range of investors including KiwiSaver schemes.
The RBNZ says if RMOs were “eligible collateral” for central bank liquidity that could underpin new market opportunities similar to Kauri Bonds (NZ dollar-denominated bonds offered by offshore issuers), which have “repo-eligibility”.
“We believe banks would be able to create enough to replace the I-RMBS currently held by banks as collateral for borrowing from the Reserve Bank, and potentially considerably more,” the paper says.