The UK covered bond industry is hopeful that changes to covered bond legislation announced on Tuesday that make it more prescriptive, without placing extra burdensome demands on issuers, could win RCBs more credit from investors, particularly those elsewhere in Europe.

HM Treasury published an amendment to covered bond legislation alongside the Chancellor’s Autumn Statement, as well as an explanatory memorandum, a summary of responses to a consultation carried out earlier this year, and an impact assessment of the proposed changes to the UK Regulated Covered Bond (RCB) framework.

The amendment introduces an option for issuers to declare that their covered bonds are backed by only a single type of asset; excludes securitisation as an eligible asset; sets minimum overcollateralisation at 8%; creates a formal requirement for UK covered bond programmes to appoint an asset pool monitor; and clarifies the Financial Service Authority’s (FSA’s) powers to require issuers to publish information for investors. With respect to the latter, the Treasury said that the FSA is proceeding with a requirement for loan level data. (Click here for more detail about the measures announced yesterday, including a link to the Treasury documents.)

Tom Ranger, head of secured funding at Santander UK, said that the Treasury’s announcement did not contain any surprises.

“What was in the consultation is largely what we ended up with,” he said. “The most important thing is that we have a fantastically strong legislation in the UK.”

However, he said that the RCB framework does not get enough credit from market participants elsewhere in Europe, and UK RCB issuers therefore hope that the Treasury’s and the FSA’s work on the legislation will give it more publicity.

“Only UK issuers appreciate how hard it is to comply with the legislation, how tough and rigorous it is to qualify as an RCB issuer,” said Ranger.

Bernd Volk, head of covered bond research at Deutsche Bank, welcomed the Treasury’s move as “overall, a step in the right direction” by inserting more details in the legal framework instead of focussing mainly on contractual enhancements.

Spread savings eyed

In various documents released in parallel with The Regulated Covered Bonds (Amendment) Regulations 2011, the Treasury said that the new measures are targeted at improving the protection given to bondholders under the UK covered bond regime. In the impact assessment of the amendment the Treasury explained why it had opted to purse “gold plating” of the UK legal framework and render it more prescriptive, in line with other jurisdictions, particularly Germany and France.

“Numerous market participants said they believed UK covered bonds would appeal more to investors if the Regulations took a more prescriptive approach in line with these other jurisdictions,” said the Treasury. “Some investors used to investing in covered bonds subject to prescriptive rules did not believe that the UK’s high-level principles could reliably deliver quality standards equivalent to those in more prescriptive jurisdictions.”

HM Treasury

To not opt for “gold plating” – described as exceeding the minimum requirements of EU legislation – would constitute a regulatory failure, according to the Treasury, because it would impose “unnecessary costs on UK society”, with both an economic rationale and quantitative evidence supporting this view.

The Treasury said that its proposals are intended to reduce uncertainty among investors about the quality of UK covered bonds, and that a significant reduction will manifest itself in a lowering of spreads. It reported investor indications that spread savings from the overall package could amount to between 10bp and 20bp, although prevailing volatility made it difficult to make predictions.

The Treasury also referred to a Bank of International Settlements (BIS) analysis as showing that the residual component in spread differences that could be attributed to perceptions of regulatory regimes was around 8bp, but settled on what it described as a conservative estimate of 5bp as its central assumption for the reduction in spreads that could be triggered by the measures. This is below investor estimates and represents a reduction of only 10% in the prevailing difference between UK and other countries’ covered bond spreads, it said.

Deutsche’s Volk said that a direct spread impact in the short term is unlikely.

Jörg Homey, head of covered bond research at DZ Bank, said that the argument that any reduction in investor uncertainty brought about by the changes would lead to lower spreads is a reasonable one, but that it is very difficult to pin down a specific number to capture such savings.

“I am sceptical that you can be precise on how legislation can impact spreads in the secondary market,” he said.

In addition, the Treasury appears to be making mandatory what is in many ways already best practice, he added, which means that there should not be any changes to the way in which UK covered bond programmes are set up.

Indeed, the Treasury noted that measures such as providing issuers with an option to declare the composition of cover pools (as single asset or mixed) and the introduction of fixed minimum overcollateralisation will impose no to no material change on issuers.

According to the Treasury, questions such as allowing access to the Bank of England Discount Window facility for post-insolvency cover pools, asset encumbrance, and the treatment of covered bonds in a bail-in were discussed, but either left to the Bank and the FSA to deal with or deferred.

Volk drew attention to the importance of access to liquidity for post-insolvency cover pools to reduce refinancing risk and said that a failure to provide positive clarification of this would represent a missed opportunity to create a level playing field with Germany and France, and soon probably Austria and Luxembourg, too.

“Admittedly, central bank access is nothing else than systemic support,” he said, “but it seems justified given the macroeconomic importance of mortgage lending.”

FSA aligns with BoE on disclosure

The move to loan level reporting, on which the Treasury said the FSA has decided, will impose only minimal additional costs on most issuers, according to the authorities, given that the reporting standards the FSA will propose are similar to those developed by the Bank of England, “with which almost all issuers have indicated they are already planning to comply”.

However, in a summary of responses to the joint consultation the Treasury said that most issuers opposed loan level disclosure on the grounds of cost and confidentiality, and because they believed investors did not require such a level of detail.

It explained the FSA’s decision to proceed with loan-level detail: “This is on the grounds that the proposed changes will limit marginal costs for issuers while providing very substantial transparency and flexibility for investors to utilise the data to suit individual needs.”

The Covered Bond Report understands that the FSA is aiming to publish a Policy Statement in a few weeks, and that this will include more information about disclosure requirements.

The Treasury said that as part of the consultation process the FSA has worked closely with issuers to assess the costs of the loan level reporting requirement and minimise the burdens involved by amending the format of the proposed reporting requirement.

The only area where major transitional costs associated with the changes to the UK regime were reported was, according to the Treasury, “in relation to one issuer that indicated they did not intend to comply with the existing Bank of England reporting requirements with which the FSA is aligning its proposed requirements”.

It said that transitional costs given by issuers during the consultation for IT procurement required to comply with the Bank of England’s existing disclosure requirements ranged from around £100,000-£300,000, but with one estimate of over £900,000.

Given the adjustments the FSA has made to the format for the proposed reporting requirements, said the Treasury, “the FSA believes the figure of £300,000 is most appropriate to use as the transitional cost for the one issuer not already planning to comply with the Bank’s reporting requirement.”