Fears are mounting that covered bonds could fail to secure a position as Level 1 assets after it emerged that, as reported by The CBR, the EBA’s Board of Supervisors is against such a recommendation, but the head of the ECBC says inclusion at the top of LCRs remains a real possibility.

The Danish parliament yesterday (Thursday) released a Ministry of Economic & Business Affairs document saying that the European Banking Authority (EBA) Board of Supervisors has indicated it will not recommend that covered bonds are considered Level 1 assets when it makes its report to the European Commission on the matter after a meeting on 11 December.

According to industry sources, at a recent EBA meeting countries including Denmark, Finland, Germany and Luxembourg are said to have supported the case for covered bonds being recommended as Level 1 assets, with others – i.e. a majority – supporting alignment with Basel III, which would leave covered bonds as Level 2 assets (see here for Wednesday’s coverage). While some central and eastern European countries who were in favour of Basel III alignment are understood to have been less concerned about the covered bond issue and more focussed on government bond eligibility, representatives of France, Italy and Spain are said to have actively opposed covered bonds’ Level 1 claim. The UK is understood to have suggested a compromise where both cases are presented to the Commission in the EBA report, although the country has previously been against covered bonds being considered as Level 1 assets.

Many industry officials who have been lobbying for covered bonds since the initial Basel III proposals came out and who believed that they were winning the argument have been taken aback by the EBA Board of Supervisors’ position.

An official from one of the supportive countries said that he is “extremely disappointed”, while another said that the EBA’s position was unexpected.

“That the board did not really follow the technical conclusions is a surprise,” he added.

He was referring to a presentation at an EBA public hearing on 30 October where an analysis of various asset classes’ liquidity carried a “very preliminary” draft ranking that put covered bonds alongside government bonds. The release of this analysis had been taken as a strong argument in favour of covered bonds’ case.

Industry representatives were critical of the regulator’s stance.

“The EBA is supposed to be a technical arbiter, but here they have based their decision on political judgements,” said one.

He noted that the EU authorities have not previously committed themselves to full Basel alignment.

“Parliament had fairly strong views on that,” he added.

Luca Bertalot, head of the European Covered Bond Council, said that even if the EBA Board of Supervisors is not behind recommending covered bonds’ inclusion as Level 1 assets, the situation could change before the final decision on LCRs is taken in June 2014.

He said that there is general sympathy for covered bonds’ case but that an important stumbling block may have been a AA- threshold for covered bond eligibility that has been proposed as this would exclude covered bonds of several countries.

“We have been delighted to see that the EBA technical analysis supports the inclusion of covered bonds in Level 1, confirming the indication made in the CRR text,” he told The Covered Bond Report. “We think that the current political debate at the EBA Board of Supervisors level highlights the need of a further reflection on the appropriateness of a rating trigger that can create serious competition issues, jeopardising the general support for covered bonds’ case.

“We are fully in line with the G20 recommendation of removing rating triggers from legislation and it is important to identify alternative solutions to allow a smooth political support to the inclusion of covered bonds in Level 1. The European Commission will consider all these points before June 2014.”

An industry representative from one of the pro-Level 1 countries said that the Commission will be “fully free” to assess the results of the EBA’s analysis and to make its own decision, even if the likely EBA position was unwelcome.

“There’s a good opportunity to convince the Commission that covered bonds as Level 1 liquid assets would be appropriate,” he said.

Another official noted that as part of the EBA’s processes the European Central Bank and European Securities & Markets Authority will have the opportunity to provide input on the regulator’s position before its final report to the Commission.