The direction of most pan-EU regulatory treatment of covered bonds is positive, with EMIR an exception and their LCR status under the CRR still unknown, Moody’s noted in a 2014 global outlook today (Tuesday), which also flagged its expectation of moves in other regions, such as enactment of a law in Korea.

The rating agency said that ongoing regulatory and legal developments in Europe will strengthen the credit quality of covered bonds in 2014 and increase transparency for investors, citing developments such as increased clarity on the protection for covered bonds from bail-in following agreement of the draft Resolution & Recovery Directive (RRD) in June.

The rating agency has been consulting on a proposal to alter the issuer anchor point for covered bond ratings (in the European Economic Area) to reflect that there is a greater probability that an issuer would continue to meet its covered bond obligations despite a default on its senior unsecured debt. The consultation ended in October, with Moody’s today saying that “we will refine our analysis as more certainty emerges on how regulators will implement and apply the RRD”.

In general, there is a clear positive direction to most pan-EU treatment of covered bonds, according to the rating agency, with one exception being the European Markets & Infrastructure Regulation (EMIR), which could have a negative impact on the use of covered bond swaps.

The rating agency also noted that the regulatory treatment of covered bonds for the purpose of the liquidity coverage ratio (LCR) in the Capital Requirements Regulation (CRR) is currently unknown, despite a supportive preliminary ranking by the European Banking Authority (EBA).

As previously reported in The CBR, fears have been mounting that the EBA will not recommend an approach that would support covered bonds as Level 1 liquid assets for the LCR when it reports to the European Commission on its findings. This is due to happen by 31 December, with a meeting of the EBA Board of Supervisors, the main decision-making body of the EBA, scheduled for tomorrow (Wednesday). (See here for the most recent previous coverage.)

Moody’s said that covered bonds will also benefit from stabilising sovereign credit quality, noting that the pace of sovereign downgrades has eased and that fewer sovereigns carry negative outlooks.

And while European issuing banks will continue to face pressure on their credit quality, the number of covered bond downgrades resulting from negative issuer credit migration will continue to decrease in 2014, said Moody’s, with negative indicators on issuer ratings on a decreasing trend.

However, it noted that the impact of the RRD on the credit strength of issuers remains uncertain and that the above trend may be reversed in 2014 given uncertainties around levels of systemic support for EU banks.

The global perspective

Looking beyond Europe, Moody’s said that in North America it only expects material covered bond activity in Canada, as new programmes emerge under the country’s 2012 legal framework.

In Asia ex-Japan the covered bond market is still at a “developmental” stage, said the rating agency, but adding that it expects new issuance from Korea and Singapore in 2014.

“Korea is still leading on both legal and regulatory fronts,” it said.

The South Korean Financial Services Commission introduced a draft covered bond law in October 2012 and the bill on a Covered Bond Act was approved by the country’s cabinet in January 2013.

Moody’s noted that the draft law was submitted to the country’s parliament thereafter and that it expects that the law “will come into force within the next couple of quarters”.

“The proposed law would be credit positive for Korean covered bonds,” it said. “Among other things, it provides for strong legal protection on dual recourse and cover pool registration.”

In Singapore, meanwhile, the Monetary Authority has been in discussions with market participants despite not making any further official announcement since publishing a consultation paper on covered bond guidelines in March 2012, noted Moody’s.

“Legally and technically, publication of the final covered bonds guideline by MAS is not a pre-requisite for issuing covered bonds in Singapore,” said the rating agency. “However, we expect that the first Singapore covered bonds issuance will only materialise after final guideline has been published because Singapore is a heavily regulated jurisdiction and regulatory blessing is a de facto requirement.”

It said that Singapore is expected to publish covered bond guidelines next year.