Banks’ preparations for TLAC and MREL could impact the volume and nature of covered bond issuance in 2016, according to analysts, but with treatment of the asset class generally positive, regulation’s impact on the asset class is expected to be limited.

In reports on their outlook for covered bonds next year, analysts said regulation will on balance continue to be generally positive for the asset class, with some adding that regulatory developments will play a smaller role than other market drivers, such as the European Central Bank’s covered bond purchase programme, in particular on covered bond performance.

“Regulation can have an impact on spreads – mostly not on short notice but instead on a longer timescale,” said Michael Spies, covered bond and SSA strategist at Citi. “And yet, for 2016, regulation will also take a backseat.

“On the one hand, this is due to the overarching ECB impact. On the other hand, we don’t see spread-driving regulatory issues for next year.”

However, some analysts highlighted TLAC (total loss-absorbing capacity) and MREL (minimum requirement for own funds and eligible liabilities) requirements as having the potential to negatively affect covered bond supply in 2016. Analysts said that issuers had this year actively built their buffers of loss-absorbing capital in order to meet requirements, with some adding that they expect this focus to remain next year.

Fritz Engelhard, head of strategy at Barclays, said the capital requirements could have a negative impact on covered bond issuance in 2016, as secured liabilities are generally exempt from bail-in and banks with insufficient amounts of bail-in-able debt under TLAC and/or MREL rules may be forced to issue more subordinated and senior debt to fulfil the respective requirements.

Engelhard noted that Barclays credit analysts estimate that TLAC could globally drive more than $100bn (Eu92.2bn) of annual incremental unsecured bank debt issuance over the next three years.

Depending on decisions relating to statutory subordination of senior debt, Engelhard said covered bond issuance could therefore be somewhat reduced or geared towards shorter maturities.

“While there are still some moving parts, we would think that the implementation of minimum TLAC requirements will only have a limited effect on covered bond supply,” he said. “In particular, European banks could eventually opt for the issuance of covered bonds maturing in 2018 and 2021 in order to gain flexibility to issue more TLAC-eligible debt thereafter.”

Maureen Schuller, head of financials research at ING, agreed covered bond issuance could be affected by TLAC, while noting that covered bonds were the only bank bond funding product that recorded a rise in issuance from 2014 levels in 2015, as senior unsecured and subordinated issuance fell.

“In our view, this trend is going to reverse next year following the recent final drafting from the FSB regarding the TLAC framework for G-SIBs and once further country-by-country clarity is obtained regarding the insolvency treatment of senior unsecured bonds,” she said.

However, Anne Caris, research analyst at BAML, said TLAC and MREL are not direct threats to covered bonds, and that any impact should be marginal as only a handful of banks will prioritise eligible bonds over covered bonds to build their curve.

“Covered bonds remain strategic for mortgage lending, even more so if ECB QE2 were to compress yields further,” she added.

Others agreed that TLAC and MREL requirements had been a drag on covered bond issuance this year, but said some issuers could change their strategy in 2016.

“In 2015, global systemically important financial institutions in particular have placed a lot of focus on TLAC/MREL buffers and did not bother too much about covered bonds,” said Florian Eichert, head of covered bond and SSA research at Crédit Agricole. “In our view, this will still be an issue for many in 2016, but we do expect some national champions to refocus on covered bonds, albeit from a very low base.”

Société Générale analysts added that a provision to disincentivise banks from holding other banks’ TLAC in the final regulation should reduce bank treasuries’ appetite for bank senior paper, in particular floating rate notes, thereby pointing to wider spreads between senior and covered bonds.

Owing in part to TLAC, the issue of asset encumbrance became less pressing this year, analysts said, having been more prominent in 2014.

“Asset encumbrance is a lingering discussion,” said Eichert, “but has softened as the focus has shifted to increasing the buffer that can take losses – capital and TLAC.”

This lifting of pressure should contribute to favourable economics covered bonds in 2016, he added.

Citi’s Spies said that it is unlikely there will be any serious approaches on a European-wide level to cap covered bond funding to decrease asset encumbrance in 2016.

Analysts also noted that Solvency II will come into effect on 1 January. Eichert said the impact of Solvency II on covered bonds will be neutral or, at worst, slightly negative. He noted that for an insurance sector investor, the different capital charges would mean different spread requirements. For a 10 year triple A-rated covered bond, the additional capital cost versus sovereign debt is around 36bp, he said.

Spies agreed that the impact of Solvency II on covered bonds will be limited, adding that many insurance companies and pension funds are likely still calibrating their capital allocation.

“For the time being, we would not expect any particular effects on covered bond valuations,” he said, “mainly as the low rate environment makes covered bond investment challenging anyway.”

Preferential treatment under the Bank Recovery & Resolution Directive (BRRD) and in LCRs will also continue to support covered bonds next year, analysts said, increasing their attractiveness and regulation-driven demand from banks in particular.