The exclusion of covered bonds from Level 2 assets under Basel III by the Australian Prudential Regulation Authority on Monday was no surprise, according to those in the Australian banking industry, who identified potential uses for covered bonds in the Liquidity Coverage Ratio, but also indirect reasons to be concerned.

Alex Sell, chief operating officer at the Australian Securitisation Forum, told The Covered Bond Report that he was not surprised by APRA’s stance.

“The only surprise in it was the exclusion of supranationals – including Kangaroos potentially from AAA issuers – from Level 1 and Level 2 assets,” he said. “But all the rest was unsurprising.”

Reserve Bank of Australia

Indeed he agreed that covered bonds, from Australian issuers at least, would need to establish a track record in order to meet the Basel Committee’s criteria for Level 2 assets.

“For the time being, it’s an entirely fair point,” said Sell.

“That said, if covered bonds join RMBS in being eligible collateral in the Reserve Bank of Australia’s ordinary Open Market Operations then they will be eligible for the new committed secured liquidity facility, which is a means by which Australian banks will be able to generate alternative prudential liquidity to meet the LCR,” he added. “This was agreed to by the Basel Committee for those countries that have a lack of Level 1 and Level 2 assets in their local markets.”

However, lawyers at Clayton Utz said agreed that this is a possibility, they pointed out that the committed secured liquidity facility is only to be accessed in a last resort, according to APRA and the RBA, when an institution has demonstrated that it has taken “all reasonable steps towards meeting their LCR requirements through their own balance sheet management”.

They were nevertheless positive about APRA leaving the door open to future inclusion of covered bonds as Level 2 assets.

“APRA has already indicated that it will consider expanding the list of LCR-eligible assets pending the outcome of testing by the Basel Committee on the liquidity characteristics of Level 2 assets and APRA’s assessment of market developments over the period leading up to 1 January 2015,” they said.

However, one market participant said that APRA’s position on surpranationals might have negative implications for covered bonds’ potential future eligibility.

“They haven’t explained why SSAs are excluded, unless they are implying that they have failed to pass the tests of being deep and liquid,” he explained. “And perhaps that isn’t that odd if you are just looking at Kangaroo issuance because there isn’t that much compared with, say, euros and US deals from those issuers.

“But if SSAs can’t get over that hurdle, on that basis covered bonds out of Australia are going to take a long time to become eligible.”