Qualification for the Covered Bond Label should be linked to CRD-compliance in what would be a “logical” next step for the initiative, an ECB official told an ECBC plenary yesterday (Wednesday), a day after the industry body held off on just such a move.

Ulrich Bindseil, director general, market operations, European Central Bank (ECB), expressed support for the Label initiative of the European Covered Bond Council (ECBC) in a keynote speech at the council’s plenary in Barcelona, citing benefits such as improved transparency and market discipline, and the ringfencing of the asset class.

He acknowledged that the label is only a recent initiative and that there will not be a “universal solution” given continuous change in legislation and best practice plus the remaining heterogeneity of legal frameworks across Europe and a desire to retain flexibility.

Ulrich Bindseil

However, he flagged areas for improvement, noting that further development of the Label was important to maintain and potentially further the favourable treatment of the covered bond asset class in the ECB’s collateral framework. This is “not to be seen as given”, he said, and it is important not to rely on the prevailing favourable treatment of covered bonds, but to work to protect it.

The Eurosystem collateral framework relies on broad institutional categories in addition to ratings and maturity brackets, noted Bindseil, and the Covered Bond Label has an important role to play in helping to maintain the logic of covered bonds being treated as a single institutional category.

His recommendations for how the Label could be improved centred on three aspects, the first being the potential harmonisation of national transparency templates. He then noted that central bank and regulatory approaches to covered bonds use Capital Requirement Directive (CRD) compliance as their basis and not, as does the Label, UCITS-compliance, and said that it is “logical that the label does not ignore those developments”.

The CRD has taken a more important role under the ECB’s collateral framework recently, with own issued covered bonds, for example, now having to comply with the directive to be eligible as collateral, and restrictions on the inclusion of most ABS in cover pools also aligning the ECB’s collateral framework with the CRD.

However, Bindseil acknowledged – when pressed on the matter by a plenary delegate – that the ECB has moved “one step to CRD but we do not have it as an absolute definition”. It continues to use institutional categories under the collateral framework, which is not “extremely granular”, he said. However, he suggested that there are alternatives to this – “in principle everything is possible”.

The Covered Bond Report understands that there is strong support within the ECBC for adopting CRD rather than UCITS as a criterion for the Label. However, although a majority were in favour of the move when asked at an ECBC meeting on Tuesday, it was considered that the level of support for the move was not sufficiently broad, and the UCITS criterion has been retained.

ECBC chairman Paul O’Connor said earlier on in the plenary that it was too early in the initiative to make such a change and also noted that changes to CRD that could affect covered bond treatment are underway. However, he said that it is a topic the Label committee will be considering further and another source who attended the Tuesday meeting said that the decision taken there would not be the last word on the matter.

Another area for improvement flagged by Bindseil concerns the governance of the Label, which is awarded on a self-certification basis. This principle has served well in the start-up phase of the Label, said Bindseil, but he raised the question of whether a more stringent structure might be warranted to ensure a quality control of the information delivered.

Haircuts as market funding incentive

Bindseil also spoke about changes to the treatment of covered bonds under the ECB’s collateral framework in July, which featured the introduction of a valuation markdown for retained issuance. He said that the changes were made in response to the substantial growth of use of retained covered bonds as collateral in the past two years.

He said that because the credit quality and value of covered bonds depends on the issuer and the underlying assets, it was “logical” from the perspective of the ECB’s risk position to reflect this in the central bank’s collateral system. Posing and then answering the question of “why now”, Bindseil made the general point that central banks’ risk control frameworks are “a simplification” and that action is taken as and when certain weaknesses or concentration risks emerge and are discovered based on how banks behave.

After a substantial increase in the use of retained covered bonds as collateral over the past two years the ECB “had to react”, he said, adding that the valuation markdown should be seen as an incentive for banks to issue covered bonds in the public markets.