The European Banking Authority (EBA) has excluded covered bonds from assets it has recommended should be eligible as extremely high quality liquid assets (HQLA) for Liquidity Coverage Ratio (LCR) purposes in a report to the European Commission.

In a statement dated today (Friday), the EBA recommended only bonds issued or guaranteed by EEA sovereigns, EEA central banks and supranational institutions qualify as extremely HQLA, equivalent to Level 1 in the Basel III framework, citing the results of its analyses as well as the “great importance” of alignment with the Basel Committee on Banking Supervision rules. Covered bonds are included in a second tier of high quality liquid assets, equivalent to Level 2 under Basel III.

The recommendation confirms fears that were raised last month when it emerged that the EBA’s Board of Supervisors were likely to reject calls for covered bonds to be given Level 1 status, despite an EBA analysis published in October showing the asset class as having similar liquidity to government bonds.

The EBA today cited a lack of data on covered bond performance during real estate crises as a reason for covered bonds’ exclusion.

“Despite the excellent liquidity features showed by some covered bonds, doubts remain as to whether these findings are sufficient to justify a deviation from the international standards and their inclusion in the category of extremely HQLA,” it said, “in fact two-thirds of the observations come from markets that did not experience a real estate crisis.”

A covered bond analyst treated this justification with scepticism.

“They state that the data doesn’t cover periods where real estate markets were in deep stress and hence that the data that they have is not representative enough for them to use it,” he said. “To me they had enough data, came up with good results, and are now looking for an excuse to ignore it to get to more global harmonisation.”

The final decision, due in June 2014, will be taken by the European Commission, a point highlighted by Luca Bertalot, head of the European Covered Bond Council.

“It is important to stress that EBA merely makes proposals to the Commission,” he told The Covered Bond Report. “The Commission is, however, the one to make the final decision before the end of June 2014 and that decision can still look different to EBA’s proposals.”

The news nevertheless left market participants disappointed.

“While the EC can still decide differently than recommended by EBA, a broad-scale general Level 1 status for covered bonds now seems very unlikely,” said Bernd Volk, head of covered bond research at Deutsche Bank.

Analysts have in the meantime played down the likely impact of the news on the market.

“While making it to Level 1 would have been a very positive signal, EBA sticking close to the Basel recommendations on the LCR isn’t going to trigger any investor behaviour changes for now in my view,” said Florian Eichert, senior covered bond analyst at Crédit Agricole.