The ECB sees merit in a comprehensive EU legal framework potentially replacing national covered bond frameworks in the medium to long term, and in a response to a harmonisation consultation also took a tough stance on non-EU/EEA issuance and innovations such as CPTs.

The European Central Bank released its response today (Friday) after it was approved by the governing council on Thursday of last week (21 January). The European Commission’s consultation finished on 6 January, having been launched on 30 September as part of the Capital Markets Union (CMU) project.

Despite disagreeing with a proposition included in the consultation document that differences between national frameworks caused pricing divergence between covered bonds of different countries, the ECB said it agreed with the Commission’s assessment that it is desirable to achieve further harmonisation of specific features of covered bonds that will lead to further convergence towards a common high European standard.

“In this respect, future policy efforts aimed at harmonising covered bond frameworks should be ambitious,” it said. “Common minimum standards should be introduced in areas where the benefits of harmonisation have been ascertained.”

The ECB said that an option of voluntary convergence floated by the Commission (option 1) would not necessarily achieve the necessary convergence, and noted two variants of potential enhancements to covered bond frameworks at an EU level: envisaging enhancements to the covered bond framework that would promote further harmonisation of national regimes through the introduction of additional prudential and/or product related requirements in Article 129 CRR and/or Article 54(2) UCITS (and Solvency II) (referred to as Option 2a); and establishing a comprehensive covered bond legal framework (a so-called 29th regime) stipulating high standards (2b).

“The latter framework could initially co-exist with or potentially replace national legal frameworks over time,” said the central bank. “The ECB sees merit in the notion of a comprehensive covered bond legal framework over a medium to long term horizon, following a harmonisation and convergence process based on a dedicated covered bond legal framework.

“The ECB is of the view that further harmonisation achieved through such a convergence process would be desirable and beneficial for covered bond markets. The ECB therefore sees merit in starting with Option 2a, which could over a medium to long term horizon converge into Option 2b.”

The central bank nevertheless acknowledged that a 29th regime could increase fragmentation by introducing “yet another” covered bond model. It said that issuers would also need significant incentives to move to the framework, and that building an EU regime would be a “resource-intensive and complex legal initiative”.

It added that any transition to an EU framework should include a “sufficiently long” transition period with appropriate grandfathering provisions given the importance of the EU covered bond market.

The ECB also echoed feedback of many industry participants in saying that sufficient flexibility should be maintained to account for some diversity across national regimes, and noted that existing frameworks are generally well-functioning and in many cases long-established.

“Despite the differences in the various national covered bond frameworks, the covered bond market as it is currently structured is generally deemed well performing,” it said.

The central bank also came out against extending the definition of covered bonds, for example in relation to UCITS, to those of issuers from third countries, outside the EU/EEA. It said assessing the equivalence of non-EU/EEA regimes might be challenging and that insolvency regimes may differ substantially.

The ECB also called for the ongoing monitoring of covered bonds’ preferential risk weight treatment, citing “continuous innovation” within the asset class and as an example more pronounced usage of non-standard amortisation structures such as conditional pass-throughs.

Saying that Article 129(7) CRR transparency requirements may be insufficient, the ECB welcomed the European Covered Bond Council’s Harmonised Transparency Template as an important step forward, but called for further disclosure and efforts to make data more accessible, as well as legislative backing for this.

It also called for enhanced transparency around amendments to covered bond programmes, via consent solicitations (as reported previously by The CBR), which it noted had become increasingly common, and because binding decisions can in principle be approved by a small minority of bondholders.

“The ECB therefore believes it would be worthwhile to explore common thresholds for bondholders’ consent and quorum requirements in the case of amendments of covered bonds, as well as consent fee arrangements that benefit all bondholders following programme amendments,” it said.