The ECBC yesterday (Thursday) called for ESMA to go beyond proposals to exempt certain covered bond derivatives from central clearing requirements and exclude all such instruments given that central counterparties are unable to clear them.

The European Securities & Markets Authority (ESMA) on 11 July launched a consultation – ending next Monday – on the central clearing of OTC derivatives under the European Market Infrastructure Regulation (EMIR) whereby covered bonds that met certain conditions would be exempted from having to be centrally cleared. (See previous article for further details.)

In its response to the consultation, the European Covered Bond Council (ECBC) yesterday welcomed the acknowledgement by EMSA that covered bond derivatives have special features and the regulator’s outlining of conditions that, if met, would allow for their exclusion from central clearing obligations.

“The exclusion of this relief is essential to the proper functioning of covered bond derivatives and covered bond programmes in general,” said the industry body.

However, it said that central counterparties (CCPs) cannot centrally clear covered bond derivatives irrespective of whether or not ESMA’s conditions are met, and therefore called for all covered bond derivatives to be excluded as long as there are technical issues preventing their central clearing.

“In the meantime,” it added, “the ECBC would like to ensure that the expected exemption from central clearing will not result in a more punitive treatment in terms of capital for covered bond swap counterparties. Swap counterparties of covered bond derivatives are willing to clear them centrally but it is technically not feasible to do so for the CCPs.”

The ECBC nevertheless responded in detail to ESMA’s questions about the proposed conditions for exempting certain covered bonds so that “the full range of relevant covered bond derivative arrangements may be eligible for relief” should the regulator go ahead with using the conditions.

The ECBC’s proposed changes are largely of a technical nature, although the industry body’s responses to two conditions carry wider resonance.

Firstly, ESMA proposed as a criterion that the covered bonds the derivatives in question are related to are CRR-compliant (Article 129). The ECBC responded by calling for this to be changed to UCITS-eligible (Article 52(4)).

“There are covered bonds in Europe which are based on a very strong legal framework, offer a high quality and credit protection for investors, enjoy a strong special public supervision, fulfil generally the same conditions as Article 129 CRR-compliant covered bonds, but are backed by assets that are not listed in Article 129 CRR,” it said. “Above all, these covered bonds offer the swap counterpart the same credit protection than covered bonds compliant with Article 129 CRR, as liabilities stemming from derivatives in the cover pool must be covered at all times by law.

“The high credit quality of these covered bonds is recognised by regulators in exempting UCITS compliant covered bond programmes from the bail-in regulations in accordance with the Bank Recovery & Resolution Directive (BRRD),” added the ECBC. “Therefore we suggest that the classification of EU-harmonised covered bonds is based on the UCITS definition of covered bonds.”

The ECBC nevertheless noted that it has been pursuing its Covered Bond Label initiative and that ESMA’s proposal is in line with the industry having adopted CRR compliance as a requirement for the Label as of 1 January this year.

Secondly, ESMA also said that the respective covered bond programme would have to be “subject to a legal collateralisation requirement of at least 102%”, in line with other moves towards embedding overcollateralisation requirements in regulations.

The ECBC said that while it considers a minimum OC requirement worthy – if costly – ESMA should recognise as “legal OC” obligations upon an issuer that arise either from national covered bond laws or contractual provisions. The wording it has proposed is: “The covered bond programme to which they are associated is subject to a legal collateralisation requirement (arising through operation of statutory and/or contractual provisions) of at least 102%”.

The industry body asked for a grandfathering period to allow for national laws to be changed in the event that ESMA does not recognise contractual provisions as “legal collateralisation”.

The ECBC meanwhile called for consistency across regulations.

“Given that the discussion of OC is taking place in parallel in different regulatory files, we would also encourage the ESMA to set the same minimum requirement across the board, for example within the criteria for certain liquidity classes under the Liquidity Coverage Requirement (LCR),” it said.

Photo: EMF-ECBC offices, Brussels