The European Commission has carved out covered bonds from potentially burdensome and impractical requirements under rules published yesterday (Tuesday) on risk mitigation techniques for OTC derivatives not cleared by a central counterparty, including overruling a recent opinion from the ESAs.

The covered bond industry had already successfully lobbied to win some changes to draft versions of the rules, arguing that certain requirements were unworkable, having previously similarly won exemptions in related rules on mandatory central clearing.

However, until the final version of the rules were published by the Commission yesterday, a bone of contention remained between it and the European Supervisory Authorities (ESAs), in the form of a caveat to one of several requirements that must be met for OTC derivative contracts related to covered bonds to be treated favourably.

The requirement in question – according to the final Commission version – is that:

“the counterparty to the OTC derivative concluded with covered bond issuers or with cover pools for covered bonds ranks at least pari passu with the covered bond holders except where the counterparty to the OTC derivative concluded with covered bond issuers or with cover pools for covered bonds is the defaulting or the affected party, or waives the pari passu rank;

During discussions the ESAs had objected to “or waives the pari passu rank”, most recently in an opinion last month. They said that this clause undermined the argument that preferential treatment of covered bonds is mitigated by counterparties benefiting from a similar preferential claim over cover pool assets to covered bond holders.

However, market participants said allowing the waiver is necessary for the functioning of some covered bond structures, with the European Covered Bond Council having cited back-to-back swaps, for example, needing to be taken into account in any covered bond carve-out.

The Commission’s decision to retain the language was therefore welcomed by market participants.

The Delegated Regulation will be implemented subject to a standard objection period by the European Parliament and Council.