ESMA released final draft RTS on central clearing requirements for OTC derivatives on Wednesday that featured several concessions to the covered bond industry, but the regulator did not make all the requested changes and some laws are now likely to be changed in relation to this.

The European Securities & Markets Authority (ESMA) released proposals in July whereby derivatives related to covered bonds that met certain conditions would be exempt from central clearing obligations under the European Market Infrastructure Regulation (EMIR). (See previous coverage.)

During a consultation on proposed Regulatory Technical Standards (RTS) that ran until mid-August, the European Covered Bond Council and others argued that covered bond-related derivatives should be fully exempt from such obligations, with no qualifying criteria being necessary, given that they cannot be cleared by central counterparties, and they also raised issues with several of the conditions that ESMA had put forward as criteria for exemption.

In conjunction with releasing the final draft RTS, ESMA summarised comments it received during the consultation and gave its feedback as to why it did or did not make changes in response. However, it does not appear to have done so in relation to an ECBC argument for an unconditional exemption for covered bonds.

“It’s very strange that they didn’t say anything about the market’s view,” said a covered bond banker.

ESMA nevertheless noted that market participants had welcomed its recognition of the “specific nature” of covered bond derivatives.

“The main technical impediment as identified in the consultation paper is unilateral collateral posting which is embedded in the documentation in accordance with covered bond legal framework and credit rating agency criteria,” it noted.

And Luca Bertalot, secretary general of the EMF-ECBC, described ESMA’s final position as a “success story” for the industry’s lobbying.

“We have achieved special treatment for covered bonds in an area where this was not at all recognised at the beginning of the process,” he said.

ESMA amended the wording of some of the six criteria in response to technical issues raised by the industry that would have unnecessarily caused problems for issuers in certain jurisdictions. For example, in its first condition it changed a reference to “default” of a covered bond issuer to “resolution or insolvency”, and added “or recorded” to a condition that derivatives be “registered” in a cover pool. A condition relating to derivative counterparties being pari passu with covered bond was also relaxed.

But changes proposed by the ECBC to two other conditions were not made.

The ECBC had argued that covered bonds should only have to be UCITS and not CRR-compliant, but ESMA did not change its position, preferring the tighter criteria. The regulator also noted that, elsewhere, the ECBC had argued in favour of harmonising regulatory standards.

This could cause problems for covered bonds that are UCITS but not-CRR compliant, such as aircraft Pfandbriefe and some Danish issuance.

ESMA also clarified that a reference to a requirement for a “legal” collateralisation level of at least 102% refers to a regulatory minimum and cannot be contractually-based, and hence changed the requirement to being “regulatory”.

Michael McCormick, head of covered bond origination at Credit Suisse, said that on balance ESMA’s final draft is a good result for the industry.

“There were a lot of technical points that the industry was lobbying to get fixed and it looks like those have been picked up,” he said. “That’s good and relieves potential headaches on those fronts.

“We didn’t get the UCITS or the OC changes, but at the end of the day I think the majority of programmes that rely extensively on hedging are UCITS-compliant, and those without the minimum OC can work with their regulators to accommodate that requirement.”

Jurisdictions that are faced with addressing the final OC requirement include Norway and Sweden.

Torkil Wiberg, analyst, banking and capital markets, at Finance Norway, said that a proposal has already been put forward by the Norwegian government whereby the Ministry of Finance will have the authority to set a quantitative OC level. This is part of a new act on financial institutions that is expected to be dealt with in parliament this autumn, he said.

“OC-limits, if not necessarily regulatory, are now increasingly being incorporated into other central parts of EU regulation, such as the LCR,” said Wiberg. “It was also highlighted by the EBA, in its report, as a possible area for harmonisation.

“Of course one can argue over the specificities in the ESMA criteria,” he added, “but overall the exemption is positive.”

Jonny Sylvén, senior advisor at the Association of Swedish Covered Bond Issuers (ASCB), said that Swedish legislation will probably have to be changed.

“The Swedish issuers do not have any problems with that kind of OC requirement today,” he said. “There are discussions of other requirements in some other new regulatory changes, such as LCR, large exposures and the harmonisation project, and we have asked authorities to coordinate this.”

According to another Swedish market participant, the possibility of the ESMA requirement being met through changes to regulations set by the Swedish FSA (Finansinspektionen) has been explored, but issuers’ preferred and expected route is an amendment to Swedish covered bond legislation. He said that this should be achievable within the necessary timeframe, with the bigger Swedish issuers expected to have to comply with the RTS in the next nine to 10 months.

Credit Suisse’s McCormick meanwhile highlighted the broader context of the final draft RTS.

“The other thing that it is important to remember is that there are other, broader exemptions available,” he said, “for instance for non-financial counterparties, that you can rely in the UK and the Netherlands, for example, because the swap is with an SPV.

“They don’t even have to worry about this per se – but it’s nice to have another way out. And there is also a separate exemption for intra-group hedging some issuers can rely on.”

ESMA’s final draft RTS will be put to the European Commission and then the Council and Parliament before they come into effect.

The European Supervisory Authorities are meanwhile working on RTS for risk mitigation techniques for covered bonds that are not centrally cleared. (See previous coverage.)

“It is essential that the conditions under which covered bond derivatives would not be subject to the margin requirements for uncleared OTC derivatives be fully aligned with the conditions provided for the clearing obligation exemption,” said McCormick.