Milestones in the history of the Pfandbrief
In the course of its 250-year history, the Pfandbrief has evolved into one of Germany’s top financial exports and is rightly regarded as playing a leading role in shaping the European covered bond market. A brief and concise overview of the various milestones in the history of the Pfandbrief can be found here.
Milestones 1769 - 2019
Frederick the Great, King of Prussia, issues a cabinet order that lays the foundations for the first Pfandbriefe to be issued. The aim of these instruments is to restore the creditworthiness of large noble landowners and revive agriculture, which has been hit hard by the Seven Years' War and a severe financial crisis.
Establishment of the Silesian 'Landschaft' (cooperative of noble landowners), issuer of the first 'Landschaft' Pfandbriefe. These instruments, which are designed with various security mechanisms and are freely transferable, prove very popular and are widely imitated, not least because with the rise of the third estate from the mid-18th century onwards, a class is emerging that is willing to save and to finance foreign investments.
The Pfandbrief system is put to the test during the Napoleonic Wars (1792 - 1815), which result in significant losses of earnings in agriculture and a severe famine. Servicing Pfandbrief creditors becomes a challenge. Interest payments have to be deferred; loans must be taken out in order to service creditors, while state guarantees are also needed. Nevertheless, none of the Landschaften and none of their Pfandbrief issues have to be liquidated.
Innovation. Prussian agricultural reforms lead to changes in the legal construction of Pfandbriefe. Personal liability for landowners is dropped, with the Landschaft now acting as an 'intermediary' between the landowner and the Pfandbrief creditor. The 'Güterpfandbrief' (Pfandbrief on a specific property) becomes a partial debenture of the issuing Landschaft. As before, however, loans are not paid out in cash, but in Pfandbriefe. It is up to the borrower to try and place them.
Early industrialisation. Germany makes a poor start to the Industrial Age; with its territory fragmented, it uses different units for measurement, weighing and payment. Transport is underdeveloped, which further impedes free trade. While the abolition of serfdom, progress in medicine and technology, and potatoes and coal all play an important part in paving the way for future prosperity, in the short term they lead to huge population growth, mass unemployment and poverty.
Industrialisation leads to a rise in demand for capital, including for the construction of residential and commercial property. Private mortgage banks are set up in Germany based on the model of Crédit Fonciere. They grant cash loans against mortgage collateral and refinance themselves through Pfandbriefe. The Pfandbrief becomes a bank bond. However, Pfandbrief regulations vary widely between different parts of Germany, resulting in a patchwork that hinders the development of a market for Pfandbriefe.
The Franco-Prussian War of 1870 - 1871 leads to the establishment of the German Reich, as driven forward and long desired by Prussia. High reparation payments by France lead to an economic boom in Germany and facilitate its industrial catch-up. However, in the 'founders' crisis' of 1873, the bubble formed following speculation in industrial stocks bursts. Small investors lose their savings; anyone who can switches to comparatively safe investments such as Pfandbriefe.
A real estate crisis occurs, with speculative lending and in some cases criminal business practices causing individual mortgage banks to falter. Various large banks set up associations for the protection of Pfandbrief holders, in order to maintain investor confidence. Any losses suffered can thus usually be compensated during subsequent restructuring.
The German Mortgage Bank Act (Hypothekenbankgesetz, HBG) comes into force on 1 January 1900. It eliminates the previous, fragmented legal foundations and ensures uniform regulation across the Reich for the activities of mortgage banks and their state supervision, and in particular for the protection of Pfandbrief creditors by granting them preferential legal rights in the event of insolvency. Strict normative basic rules, i.e. the specialisation, cover and matching principles, now provide a clear outline for the business model of mortgage banks. Formation of the special committee for mortgage banks in 1902 means that for the first time there is a joint special interest group.
Germany undergoes a period of rapid industrialisation and within just a few decades catches up with the leading industrial nation, England. About 40% of the population works in industry. Housing construction in cities is unable to keep up; the new social class of factory workers lives and works in appalling conditions. Fearing a rebellion, the government alleviates the worst hardships with social legislation that sets an example to Europe, regulating industrial safety, provision for old age pensions and health insurance.
The 1919 Treaty of Versailles obliges Germany to make reparation payments. The government's drive to increase the money supply by printing banknotes leads to hyperinflation, causing the German economy and banking system to collapse. Even after the 1923 currency reform, the capital market is flagging. The introduction of a gold Pfandbrief succeeds in winning back investor confidence, with the combination of a tried and tested product and a precious metal of stable value helping to overcome the trauma of inflation.
The banking crisis in Germany triggered by the global economic crisis reaches its peak in 1931. Bond prices come under pressure, including on the Pfandbrief market. Stock market trading is suspended. When it opens again in 1932, Pfandbriefe quickly become the best-performing fixed income securities, consolidating their image as a byword for investment security. The 1930 amendment to the Mortgage Bank Act had previously successfully obtained protected designation for Pfandbriefe.
The Second World War. Germany surrenders. The destruction is devastating. Inflation is rife, making a further currency devaluation necessary. Mortgage banks must accept deep cuts. However, equalisation claims against the public sector enable them to make regular payments to service Pfandbrief creditors. Targeted measures to revitalise the capital market are not introduced until after 1950.
Europe needs other ways to resolve conflicts and secure its future. By founding the European Economic Community, Belgium, the Federal Republic of Germany, France, Italy and Luxembourg lay the foundations for the development of the European Union.
The European Mortgage Federation (EMF) is established in Brussels in 1967 on the initiative of Belgium and the Netherlands. It is joined a year later by the Association of Private Mortgage Banks (Verband privater Hypothekenbanken), which in 1992 initiates the establishment of a Pfandbrief Committee at the EMF. In 2004, this evolves into the European Covered Bond Council (ECBC) we have today.
Real estate credit reform. The reform takes into account changes in the markets and makes mortgage banks more competitive. Public-sector lending is declared a 'second principal business', issuing limits are extended and issues of non-collateralised bonds are permitted. Mortgage banks can now grant subordinated financing, provide pre-financing and bridge loans, and award loans to states in the European Community.
The fall of the Berlin Wall. The Berlin Wall 'falls' on 9 November, ending the division of Germany following the Second World War. This is primarily the result of reforms initiated by the Russian politician and state president Mikhail Gorbachev, which also end the Cold War in Europe and thus pave the way for EU expansion towards the east.
Against the backdrop of German unification and the Maastricht process, the Mortgage Bank Act (HBG) undergoes comprehensive amendments. While maintaining the established principles, the area in which banks can operate is extended to the European Economic Area. Public-sector bonds may now be marketed as 'Public Pfandbriefe', strengthening the position of Pfandbriefe both nationally and internationally. The Association of German Mortgage Banks (Verband deutscher Hypothekenbanken, VDH) is now single-handedly responsible for Pfandbriefe, following the disbandment of the joint service for products of Pfandbrief institutions that had existed since 1955.
Competitive pressure on the German Pfandbrief increases. Investment preferences of institutional investors lead to the creation of a new market segment, the 'Jumbo Pfandbrief'. At the same time, the Pfandbrief concept is gaining popularity in Europe, partly thanks to the efforts of the Association of German Mortgage Banks (VDH). The collective term 'covered bonds' now covers a wide variety of new products that have very different legal constructions. Once again, the VDH has the task of emphasising the special quality criteria of the Pfandbrief.
The German Pfandbrief Act (Pfandbriefgesetz, PfandBG) replaces the Mortgage Bank Act (HBG) as the legal basis for the issuance of Pfandbriefe. Triggered by the loss of the specialist bank principle, the privilege of issuing Pfandbriefe is now linked to the fulfilment of high quality standards for the product and is no longer linked to the issuer. The Association of German Mortgage Banks (VDH) responds to this by establishing itself as an overarching special interest group for Pfandbriefe as a product, and VDH becomes vdp.
Speculation in the US housing market culminates in the collapse of the US bank Lehman Brothers. In Europe, the global financial crisis results in a banking crisis and ultimately a euro debt crisis. Nervousness paralyses the interbank market. However, the Pfandbrief enjoys a high level of investor confidence and proves to be a reliable funding instrument. Although still relatively new, the Pfandbrief Act withstands the test, not least because weak points that become apparent during the crisis are identified swiftly and rectified through amendments to the law.
Basel III. The reform of global banking regulation initiated in the wake of the financial crisis is approved and subsequently undergoes several revisions and amendments. The complex regulations are intended to increase financial stability and contain much stricter rules on capital, liquidity and debt ratios. The Pfandbrief is systematically given privileged status as the only private capital market product. The provisional end point is the new standards agreed in 2017, in accordance with which banks will have to calculate their capital requirements in future.
Brexit. In a referendum just under 52% of the British public vote for the United Kingdom to leave the European Union. The reasons are complex and the consequences are difficult to predict. The impact on Pfandbriefe will at any rate be limited, as the third-country regulation means that British cover assets will remain eligible as cover even after Brexit.
Climate change & green finance. The European Commission presents an action plan for promoting sustainable investment. Discussions cover a classification system for green assets, the creation of regulatory standards and incorporation of sustainability aspects into banks' risk management. While these ideas do not go unchallenged, a subject that has been discussed for years becomes more prominent and puts pressure on the capital market to innovate.
On the 250th anniversary of the Pfandbrief, an agreement is reached in Europe on a legislative package to harmonise covered bonds. It bears the hallmarks of the Pfandbrief Act; based heavily on principles, it defines key quality features and leaves room for established national products to develop. History has shown that tradition and innovation and the establishment and further development of quality standards are the basis of the Pfandbrief's success story and will continue to be so in future.