The ECBC has again urged ESMA to allow for an exemption of covered bonds from central clearing obligations under EMIR, arguing in a consultation response on Tuesday that not doing so would be unworkable and unfair on the asset class.

ESMA's premises in Paris

Yesterday (Thursday) was the last day of a consultation by the European Securities & Markets Authority (ESMA) on a discussion paper it released in mid-July on central clearing obligations under the European Market Infrastructure Regulation (EMIR) (see previous coverage here).

The European Covered Bond Council had argued for an exemption for covered bonds from central clearing obligations, citing Recital 16 of EMIR, which said that certain aspects of how derivatives are treated in covered bonds should be taken into account. However, ESMA in its subsequent discussion paper rejected this and gave no exemption – although it did show an understanding of the issues that covered bonds face, posing four questions in relation to this.

In its response to the discussion paper, the ECBC reiterated its arguments that covered bonds should be offered an exemption, citing further discussions with central clearing counterparties (CCPs), which have yielded no solution to the issues facing the asset class, as well as challenges the asset class would face that the ECBC says ESMA has not fully acknowledged.

“At the present time, imposing clearing obligations on OTC derivatives contracts in the cover pools of covered bonds would have severe implications for covered bond issuers and investors, as no CCP is able to clear those derivatives contracts in their current format (i.e. the bankruptcy remoteness nature of these derivatives and unilateral collateral posting),” said the ECBC in its response. “Imposing such an obligation on covered bond derivatives could detrimentally affect the smooth functioning of the covered bond market and, in particular, jeopardise its liquidity management system and destabilise the risk hedging architecture currently in place.

“The justification for an exemption of covered bond derivatives lies in legal and technical provisions that impede the central clearing of such derivative transactions,” added the ECBC. “We believe that such technical exclusion would not increase the risk profile of these derivatives and, therefore, should not be compensated by higher risk weightings, which would be deemed unfair and would add an unnecessary financial burden on this asset class which has been vital for the European banking industry, notably during financial turmoil.”

The consultation on the discussion paper is to inform draft regulatory technical standards that will then be subject to a further consultation, with the European Commission having the final say.

“Considering the lack of short or medium term solutions and the structural impediments faced by covered bond issuers,” said the ECBC. “we urge the ESMA and the European Commission to keep all options open.”