The EBA yesterday (Tuesday) endorsed the preferential risk weights assigned to certain covered bonds but recommended adding qualifying criteria and excluding certain asset types as eligible collateral, and an EBA official told The CBR that its recommendations are about protecting investors.

The recommendations contained in the report are for the European Commission, which mandated the European Banking Authority (EBA) to provide advice on the appropriateness of the prevailing risk weight treatment of covered bonds and that of covered bonds backed by residential guaranteed loans, aircraft liens and mortgage-backed securitisation (MBS) units. The report also delivers on a mandate from the European Systemic Risk Board (ESRB) to identify best practices in relation to certain aspects of covered bonds.

The report largely confirms the recommendations that the EBA previously told market participants it intended to make – these were set out in a public hearing in London on 10 June.

“Except for the proposal for additional transparency requirements as part of Article 129 (7) of the CRR, compared with last month not much has changed,” said Florian Eichert, senior covered bond analyst at Crédit Agricole. “In the final report the EBA merely adds some more detail to the OC and liquid asset requirement recommendations.”

Joost Beaumont, fixed income strategist at ABN Amro, said that that the EBA’s embrace of the preferential risk weights of covered bonds does not come as a surprise following the public hearing, but that “overall, it is good news”.

Lars Overby, head of unit, regulation, at the EBA, said that the authority made some minor adjustments after the public hearing, mainly in the form of clarifying certain points, but that there was no need for fundamental changes.

“We have been in continuous contact with the industry over the past year and have taken the feedback into account,” he told The Covered Bond Report. “At the public hearing, we did not perceive major industry concerns about the main conclusions presented.”

It is up to the Commission to decide how to respond to the EBA’s recommendations, but it is the EBA’s view that these should be implemented, said Overby.

“No investor has ever lost any money on a covered bond but there have been bail-outs of covered bond issuers as documented in the report, and what we are trying to do is protect investors in the event that an issuer fails,” he said. “We support the low risk weighting for covered bonds but at the same time there have to be certain safeguards.”

The EBA’s report provides a first comprehensive overview, from the regulatory and supervisory perspective, of EU national covered bond frameworks, and Iceland’s and Norway’s. This is how the EBA describes the report, but its view was backed up by external parties.

“One thing I can say at the very start is that anyone interested in different legal frameworks and how they deal with typical covered bond-specific risks will find this report to be an in depth source of detailed information,” said an analyst.

Asked to what extent the EBA’s analysis uncovered more heterogeneity than the authority had perhaps expected, Overby said that the differences between national frameworks was not that surprising.

“It is well known that the differences exist between the covered bond frameworks as regards the finer details, but so far no comprehensive overview existed and we felt it was important to document this,” he said.

One of the EBA’s recommendations to the Commission includes two considerations for the longer term.

The first is that the appropriateness of the risk weight treatment of covered bonds be monitored due to asset encumbrance levels and the impact of the EU bail-in framework, the Bank Recovery & Resolution Directive (BRRD).

A second involves the EBA expressing some support for more harmonisation, saying that “further convergence of national legal/regulatory and supervisory covered bond frameworks should be achieved, so as to further support the existence of a single preferential risk weight treatment to covered bonds in the EU”.

The viability of and case for harmonisation in covered bonds is on the Commission’s agenda.

Overby said that the EBA sees some merit in achieving further convergence of national covered bond frameworks, but that it is up to the Commission to decide on whether and how it wishes to pursue this.

“It is up to them,” he said. “What we did is identify areas where there is a basis for convergence, which can also serve as a guide for national authorities to consider when developing their national frameworks.”

Add qualifying criteria, says EBA

In its report and opinion the EBA said that it considers the preferential risk weight treatment assigned to qualifying covered bonds via Article 129 of the Capital Requirements Regulation (CRR) “to be, in principle, an appropriate prudential treatment”.

However, while this article “sufficiently elaborates on the eligibility of asset classes, it is less specific on equally relevant aspects of the safety of the covered bond”, said the EBA.

As a result, it is recommending that further eligibility criteria be added “to cover, at a minimum, the areas of liquidity risk mitigation, overcollateralisation and the role of the competent authority, and the further elaboration of existing requirements on disclosure to investors”.

More specifically, the recommendations are for: a minimum regulatory overcollateralisation level; a requirement to mitigate liquidity risk in a covered bond programme by means of liquid assets available at all times to cover total net outflows over a certain time frame; requirements relating to the role of the competent authority in charge of special public supervision of the covered bonds; and clarification of disclosure criteria in Article 129 (7) by means of binding technical standards. (See separate article on the disclosure recommendations.)

With respect to the disclosure standards, the EBA also recommended that provision should be made for the possibility of extending the disclosure criteria in Article 129(7)(a) “to include additional variables, depending on further analysis to be developed when drafting the standards”.

An analyst noted that this point was not mentioned at the public hearing.

Beaumont at ABN Amro said that, at first glance, the additional requirements do not seem to have much impact on existing covered bonds, as some legal frameworks, such as the French or the Dutch, have been (France) or will be (Netherlands) updated, complying with the new rules.

“As such, the impact on the covered bond market will be limited,” he said. “However, looking forward, it seems that further convergence of the covered bond frameworks is likely, which in our view will only strengthen the market.”

The EBA was also asked to look into the preferential treatment of covered bonds backed by certain asset types, namely residential guaranteed loans, aircraft liens, and MBS.

The former should remain within the scope of preferential risk weight treatment, albeit subject to additional qualifying criteria, according to the EBA, while loans secured by aircraft liens should not. These recommendations are relevant to some French covered bonds and two NordLB aircraft Pfandbriefe, respectively.

A waiver on MBS in cover pools, meanwhile, should not be extended when it expires at the end of December 2017, said the EBA. This affects some French covered bonds.