The European Commission will take into account “features specific to the EU banking system and financial markets” in addition to EBA reports and international standards when deciding on covered bonds’ status in the LCR, an EC spokesperson told The CBR.

Confirming statements included in a Bloomberg article published on Friday, Chantal Hughes, spokesperson for the European Commission (EC), Internal Market and Services, said that “the Commission is aware of the crucial importance of the covered bond market”.

The comments were sought from the Commission after the European Banking Authority (EBA) in December did not recommend that covered bonds be treated as extremely high quality liquid assets (Level 1 under Basel III) for the purposes of Liquidity Coverage Ratio (LCR) requirements in forthcoming EU legislation, despite its technical analysis showing covered bonds to be as liquid as government bonds. Instead, the EBA’s report to the Commission recommends covered bonds as Level 2, high quality liquid assets, only, subject to a 40% cap and 15% haircut.

However, the final decision on covered bonds’ LCR status will be taken by the Commission, by the end of June, a fact noted by the Commission spokesperson in an e-mail to The Covered Bond Report.

“The EBA recommendations do not have any legal force of themselves,” said Hughes. “The Commission will consider these recommendations when preparing the secondary legislation on liquidity coverage which it is required to adopt by 30 June 2014. This secondary legislation should, inter alia, specify which assets qualify as being of high and extremely high liquidity/credit quality.

“When adopting that delegated act, in accordance with Article 460(2) of the Capital Requirements Regulation (CRR), the Commission shall take into account not just the reports submitted by EBA and the international standards but also features specific to the Union banking system and financial markets.” [Commission’s own emphasis.]

In recommending that covered bonds not be Level 1 assets, the EBA had stressed the “great importance” of alignment with Basel Committee on Banking Supervision rules.

The EBA’s recommendation was met with dismay and frustration by covered bond market participants in general, but in Denmark the reaction was particularly strong and the EC spokesperson mentioned the Danish case.

“The Commission also recognises the long tradition and solidity of Danish covered bonds, in particular, and their good liquidity characteristics, even in times of acute stress.

“This is also confirmed by the technical report of the European Banking Authority.”

Denmark’s covered bond market far outstrips the size of its government bond market, with the potential ineligibility of covered bonds as Level 1 LCR assets meaning the country’s banks would be faced with a shortage of extremely high quality liquid assets.

The Danish central bank has said it would strongly recommend that countries in such a position be allowed more covered bonds in LCRs if they are excluded from Level 1, it told the EBA in a consultation response released on Friday. (See here for previous coverage.)