Canada’s financial regulator has designated Canadian covered bonds as LCR eligible assets, with Level 2A status, a move that an analyst said could pave the way for Canadian issuance to count toward liquidity buffer requirements for European bank treasuries.

The Office of the Superintendent of Financial Institutions (OSFI) issued Liquidity Adequacy Guidelines on Friday, in which covered bonds are identified as Level 2A assets, subject to a 15% haircut.

According to the text of the guidelines, covered bonds must satisfy the following conditions to be eligible for 2A status (Article 45 b)):

- either (i) have a long-term credit rating from a recognised external credit assessment institution (ECAI) of at least AA- or in the absence of a long term rating, a short-term rating equivalent in quality to the long-term rating; or (ii) do not have a credit assessment by a recognised ECAI but are internally rated as having a probability of default (PD) corresponding to a credit rating of at least AA-;

- traded in large, deep and active repo or cash markets characterised by a low level of concentration; and;

- have a proven record as a reliable source of liquidity in the markets (repo or sale) even during stressed market conditions: i.e. maximum decline of price or increase in haircut over a 30-day period during a relevant period of significant liquidity stress not exceeding 10%. [BCBS January 2013, para 52]

To count as Level 2A assets the covered bonds cannot be issued by the institution itself or any its affiliated entities.

OSFI said that the implementation date of the Liquidity Coverage Ratio (LCR) standard is 1 January 2015, adding that Canadian issuers will be required to have 100% of the minimum LCR requirement by that date.

“No phase-in period will be permitted,” said OSFI. “OSFI believes that Canadian institutions are well positioned to the meet the proposed LCR requirement in advance of January 2015.”

Canada introduced covered bond legislation in July 2012. An analyst said that covered bonds issued before it was implemented may be included as Level 2A assets if the other requirements laid out in the guidelines, as set out above, are met.

He added that if the European Commission follows recommendations from the European Banking Authority on how to treat non-European Economic Area covered bonds for LCR purposes OSFI’s decision could mean that Canadian covered bonds become LCR eligible for European bank treasuries.

“EBA recommended to apply the respective local rules for non EEA covered bonds,” he said. “At this point this is still speculation as we don’t have the final European rules yet but at least the Canadians have come one step closer and fulfilled the condition suggested by EBA in December last year.”

The European Commission is due to decide on the LCR status of EU covered bonds by the end of June. The latest expectations, based on a leaked document from European Commission staff, are for covered bonds meeting certain criteria, such as a minimum AA- rating, to be eligible as Level 1B, and others to count as Level 2A assets.