A draft European Commission proposal on LCRs grants certain covered bonds Level 1 status, albeit with an overall cap of 70% and a haircut of 7%, according to the Danish Minister for Economic Affairs and the Interior, who described the move as “a big step forward”.

The details were included in a joint press release from the Ministry of Economic Affairs and Ministry of Business & Growth this (Friday) morning, in which the respective ministers welcomed the move.

“I am satisfied the Commission has listened to our good arguments, in particular that Danish mortgage credit bonds will be classified in the highest liquidity category and are in principle recognised to be as liquid as sovereign bonds,” said Margrethe Vestager, Minister for Economic Affairs and the Interior (pictured). “That is a big step forward.”

“Now my focus is to ensure that the principles in the draft also finds its way into the final rules. The Government has worked intensely on this issue and we will carry it forward to completion, so that the Commission’s draft will also become the final rules.”

The Danish ministries noted that the proposal has still to be settled upon by the Commission and that it can be rejected by the Council and Parliament.

The press release says that under the Commission’s proposal certain covered bonds will be eligible for Level 1 status for Liquidity Coverage Ratio (LCR) requirements.

However, whereas other Level 1 assets – mainly government bonds – face no limit, covered bonds would face a 70% cap. Analysts this morning said that this is to be understood as an overall cap combining those covered bonds that are eligible as Level 1 assets and other covered bonds that are included as Level 2A assets.

The 70% cap is nevertheless higher than the 40% cap covered bonds would face under the Basel III framework as Level 2A assets only. A proposed 7% haircut for covered bonds that qualify as Level 1 assets is also lower than the 15% haircut they would face as Level 2A assets under Basel III.

According to analysts at Danske, the criteria for covered bonds to be included as Level 1 assets include a high credit rating, an issues size of at least Eu500m, and a requirement for overcollateralisation, with the credit rating requirement possibly equivalent to credit quality step 1, equivalent to a minimum rating of AA-.

While the ministries’ press release dealt with the fate of Danish covered bonds, Danske analysts said that in their understanding the proposal applies to all European covered bonds.

The proposals suggest a better result for covered bonds than discussed earlier this week and would be in line with what Karsten Beltoft, director of the Danish Mortgage Bankers’ Federation on Wednesday described as “Level 1B”. An outcome whereby the cap on covered bonds would have been increase from 40% to 60%, but the asset class left in 2A, had been characterised as “Level 2A+”.

Henrik Sass Larsen, Minister for Business and Growth, highlighted how the result would safeguard the Danish mortgage system.

“The Government has a major focus on ensuring the best framework conditions for the well-functioning Danish mortgage credit system,” he said. “If the final rules follow the draft, Danish institutions will be able to continue to hold significant amounts of mortgage credit bonds avoiding increasing interest rates and ensuring the stability of the Danish housing market for Danish home owners.”