The European Parliament’s ECON yesterday (Monday) passed a late amendment to bail-in proposals that leaves covered bondholders’ residual claims open to being partially bailed-in, with industry representatives left frustrated, but confident it can be remedied in the Trilogue process.

Courtyard of the European Parliament

The modification of the bank recovery and resolution directive in the Economic & Monetary Affairs Committee (ECON) comes took some market participants aback given that the committee previously pushed to make more explicit covered bonds’ exemption from bail-in. In October it put forward a proposal that member states “shall” rather than “may” exempt covered bonds from certain bail-in provisions, a move that was backed by the ICMA Covered Bond Investor Council.

However, in a late amendment to the directive this sentence was removed.

The Covered Bond Report understands that the passage in question read as follows going into last night’s vote (based on accepted edits), and that there were no noteworthy changes made:

“Member States shall ensure that all secured assets related to a covered bond cover pool remain unaffected, segregated and with enough funding. Neither this requirement nor points (a) and (b) of paragraph 2 shall prevent resolution authorities, where appropriate, from exercising those powers in relation to any part of a secured liability or a liability for which collateral has been pledged that exceeds the value of the assets, pledge, lien or collateral against which it is secured. Point (a) of paragraph 2 shall not prevent resolution authorities, where appropriate, from exercising those powers in relation to any amount of a deposit that exceeds the coverage under that Directive.” (Article 38: Scope of bail-in tool)

The provision that “Member States shall exempt from this provision covered bonds” was featured in an earlier compromise text but deleted in the version that was voted on last night.

The possibility of such an outcome had been raised by Spanish newspaper Expánsion in early April, but at that time the European Parliament’s rapporteur on banking resolution was quoted by Bloomberg as saying that “secured liabilities such as covered bonds shall not be subject to bail-in”. Market participants have also questioned the feasibility and usefulness of any bail-in of the residual claim covered bondholders might hold against a bank.

Wolfgang Kälberer, head of EU affairs at the Association of German Pfandbrief Banks (vdp) in Brussels, criticised the late amendment to the ECON proposal.

“It leaves covered bonds open to being made partially bail-inable, which goes against the rationale of the product,” he said. “We are very upset by this and were quite surprised.”

An investor said that the status of covered bonds in a bail-in situation is an “extremely important topic” and warned about the latest proposal from ECON.

“The latest proposal is dangerous,” he said. “Investors should look at this. I haven’t reached any conclusions, but we need clear rules about the ranking of different instruments in a bail-in.”

Another industry representative described as “strange” the wording relating to resolution authorities being allowed to exercise write-down and conversion powers with respect to “any part of a secured liability or a liability for which collateral has been pledged that exceeds the value of the assets, pledge, lien or collateral against which it is secured”.

It refers to a situation where the covered bond collateral does not cover the full value of the covered bond debt.

He said that the latest wording of the ECON proposal creates confusion and gives member states room for manoeuvre, which contradicts a push for harmonisation from the European Commission.

But industry representatives are hopeful that such provisions will not be in the final bank recovery and resolution directive following the forthcoming Trilogue process.

“Many in the European Parliament did not initially understand the impact of the deletion of the sentence granting covered bonds exemption, but now they know,” said Kälberer, “and the wording of the Council’s version of the directive is still fine.

“There are good chances to get it fixed.”

The other market participant said he is also confident that the forthcoming negotiations will allow for a more satisfactory outcome.

“This strange wording could be absolutely kept under control during the Trilogue,” he said. “It is not dramatic but just confusing.

“I don’t have any major concerns, because my understanding is that the Commission is very supportive of the covered bond story and also a very large number of Council members.”