Formal confirmation that the EU Council intends covered bonds to be exempt from bail-ins is credit positive for covered bondholders, Moody’s said today (Monday) after the European body agreed its position on a forthcoming bank resolution directive on Thursday.

The rating agency noted that covered bonds are explicitly mentioned as secured liabilities that are exempted from bail-in in the compromise proposal, whereas the original European Commission text only implicitly excluded covered bonds.

“The introduction of an effective resolution mechanism will be positive for covered bondholders if, as is intended, it supports the continued servicing of covered bond liabilities without recourse to cover pools,” said Moody’s. “In support of this objective, the EU Council’s position is explicitly to exclude covered bonds from any bail-in of liabilities of a failing bank.”

In its proposal for Article 38 on the scope of the “bail-in tool”, the Council listed “secured liabilities including covered bonds” among liabilities that resolution authorities shall not exercise write down and conversion powers over.

“Further, the compromise proposal has since been endorsed by the EU Council’s announcement of its agreed position, which refers to covered bonds as a liability ‘permanently excluded’ from bail-in,” said the rating agency.

This explicit exemption is consistent with a recent European Parliament ECON position.

The Council paper also mirrors the Parliament’s in stating that resolution authorities may bail-in covered bondholders’ residual claim if the cover pool is not sufficient to cover their claims. However, proponents of covered bonds have been at pains to point out that this is a very remote risk that does not undermine the strength of the product.

Moody’s said: “The EU Council’s agreement confirms policymakers’ explicit intention that resolution authorities exercise bail-in on claims of senior unsecured creditors (including those held by covered bondholders) where necessary to resolve a bank. While national authorities retain some discretion in this area, it is clear the EU Council intends that discretion to be an exception.”

The proposed directive is now set to enter the Trilogue process. The Council said on Thursday that the EU presidency, which is being taken over by Lithuania, should start negotiations with the Parliament with a view to adopting the directive at first reading before year-end.