A loss of favourable regulatory treatment that Moody’s says may result from a UK exit from the EU could carry credit negative effects for UK covered bonds, according to the rating agency, which might reconsider a notch of uplift stemming from BRRD treatment that they currently enjoy.

The rating agency today (Friday) cited several key EU directives and regulations under which compliant covered bonds enjoy preferential treatment: the Bank Recovery & Resolution Directive (BRRD), the directive on Undertakings for Collective Investment In Transferable Securities (UCITS), the Capital Requirement Regulation (CRR), Liquidity Coverage Ratios (LCRs), European Market Infrastructure Regulation (EMIR), and Solvency II.

Moody’s sees the potential for UK covered bonds to suffer negative consequences should they no longer have similar treatment post-Brexit – although it notes that UK authorities may negotiate for reciprocal treatment of UK and EU covered bonds, which could contain the impact.

“Negative effects if UK covered bonds no longer qualify for preferential treatment could be higher capital costs for European bank and insurance investors to hold UK covered bonds and uncertainty as to whether a covered bond programme would be preserved upon a bail-in or liquidation of the issuer,” said Jane Soldera, a vice president and senior credit officer at Moody’s.

The rating agency noted that the UK transposition of BRRD does not make specific reference to covered bonds as an instrument that is exempt from bail-in, with bondholders instead relying on a general reference to exemption for secured liabilities and able to draw comfort from the BRRD’s “strong language” on covered bonds as long as the UK is subject to the directive.

Moody’s said that in the event of Brexit the immediate fallback position in a bank resolution situation would be for UK covered bonds to be treated as any other secured debt, where they should remain exempt from bail-in (assuming bail-in rules are retained). But it said that covered bonds may be less likely to be considered a funding source that should be protected in resolution.

“Depending on any future regulatory changes, we might reconsider our current approach of adding a notch of uplift over the Counterparty Risk assessment as our anchor point for UK covered bond ratings,” said Julie Ng, assistant vice president and analyst at Moody’s. “To date, we have not yet applied this one notch uplift outside the EEA.”

Although Moody’s noted that UK authorities may negotiate for reciprocal treatment for covered bonds – and that the UK regulatory system provides for strong rules and oversight, designed to ensure covered bonds can withstand high stresses – it points out that non-EU international regulatory requirements seldom treat covered bonds as favourably as EU regulations.

Photo: Mayor of London and Brexit campaigner Boris Johnson