Participants from all sides of the covered bond industry – such as the ASCB, CBIC and Dutch authorities – cautioned the European Commission against disrupting the market in their responses to a consultation on potential harmonisation of the asset class that ended yesterday (Wednesday).

The consultation was launched on 30 September as part of the Commission’s Capital Markets Union (CMU) project. It set out three options for moving towards a more integrated European covered bond market: 1. Voluntary convergence of Member States’ covered bond laws in accordance with non-legislative coordination measures such as a Commission recommendation; 2. Direct harmonisation of national laws through EU law (Directive or Regulation) on covered bonds; 3. 29th regime as an alternative to existing national laws.

The ICMA Covered Bond Investor Council said that while there are potential benefits to a more integrated EU framework, the Commission should be careful not to water down existing strong national frameworks.

“Covered bonds represent a unique asset class with peculiar characteristics emanating from specific national laws built around it, unlike other fixed income asset classes,” it said. “The financial services industry has committed significant resources over many years to create covered bond standards in EU and non-EU countries.

“Whichever option the European Commission chooses to pursue to harmonise markets, the Commission must be careful not to needlessly disrupt a well functioning market given the history of the asset class.”

However, it said that while some CBIC members are happy with voluntary convergence under option 1, with regulatory benefits incentivising this, others believe that “anything which exists on a purely voluntary basis would effectively be too weak”. It rejects the 29th regime option as “highly impractical”.

The Association of Swedish Covered Bond issuers (ASCB) went further in arguing against harmonisation in its response.

“ASCB is critical [of] the idea of harmonisation because it will not, and cannot, cover all legal frameworks that surround and support a covered bond regulation,” it said. “The national covered bond regulation is part of a bigger package of regulations which together makes the issuance of covered bonds possible.

“If the covered bond legislation were to be harmonised it is possible that the harmonised rule would not function together with national insolvency or resolution regulations or the rest of the associated rules. This would likely end up in a less functional legal system.”

The Dutch Ministry of Finance, responding on behalf of itself and the Dutch central bank (DNB), said it agrees that a more integrated EU covered bond framework based on sound principles and best market practices would deliver benefits outlined in the Commission consultation paper. However, it also said that flexibility should be retained to account for diversity across different markets.

“This framework should be based on high quality standards and best market practices, building on national regimes without disrupting them,” said the ministry, which also rejected the 29th regime option.

The above respondents and others argued against the proposition that differences in legislation led to the divergence in spreads between covered bond markets that followed the onset of the financial crisis.

“Neither the existence of a single European covered bond framework nor the setting of minimum standards for covered bond laws would have prevented the pricing divergence,” said the Association of German Pfandbrief Banks (vdp), which finalised its response in December after giving an initial reaction to the consultation in September.

The CBIC further argued that covered bond frameworks had moderated the impact of the crisis.

“The observed spread divergence and subsequent convergence within the covered bond market was evidence of fragmentation between markets, not between different classes of covered bonds per se [emphasis in original],” said the investor body. “On the contrary, the strength of covered bond regimes in many distressed countries, for example in Spain or Portugal, was a mitigant to the effect of widening sovereign risk premia in those countries.”

“A regulatory response from the European Commission should only seek to eliminate those risk characteristics which are a function of differences between regimes in Member States,” it added, “not risks that are a function of, for example, different underlying risk characteristics of the assets or different commercial models. A market where all covered bonds price at the same level independent of issuer specific and asset specific risk factors is neither a practical nor a desirable outcome of this process.”

Fitch on Monday noted in a report on Monday that a single EU framework would not lead to homogenous ratings, saying that even under a harmonised regime or common guidelines, its country ceilings would still apply and differentiation in covered bond ratings would continue to be driven by issuer ratings, the credit quality of individual cover pools, asset-liability mismatches, and macroeconomic conditions in the respective countries.

The rating agency said that, of the topics raised by the Commission in its consultation paper, liquidity provisions upon the switch from the issuer to the cover pool as the source of payments would most affect the difference between issuer and covered bond ratings, adding that there would be most potential for upgrades in this area for countries with no mandatory liquidity protection embedded in legislation, such as Austria, Spain and Sweden. It also highlighted that clarity on the treatment of voluntary overcollateralisation, which it sees as a grey area in some covered bond frameworks, would be relevant to its analysis.

Various bodies representing issuers have also referred the Commission to the European Covered Bond Council’s extensive response, which has been finalised after a draft was published on 16 December and which cited a preference for option 1 but support for a combination of options 1 and 2.

The responses discussed above are among several that have been made publicly available. Other interested parties have meanwhile responded to the consultation without making their views public.

This article was amended after publication to state that the consultation period had been extended. This was, however, incorrect and the original timing has been reinstated.