The European Central Bank is set to treat soft bullet and conditional pass-through retained covered bonds less favourably than hard bullets in its collateral framework to reflect “additional risks”, with the implementation date to be decided in the second half of 2017.

Among several adjustments to its collateral eligibility rules and risk control measures announced today (Thursday), it said that the governing council decided to:

“Adjust the risk control measures for retained covered bonds with extendible maturities (e.g. soft bullet and conditional pass-through covered bonds) to take into account the additional risk which results from the use of such securities by the issuer itself and to ensure a level playing field between securities with comparable risks.”

The ECB said that the measure will become applicable at a date to be announced in the second half of 2017.

Among other measures announced today but which will become effective on 1 January 2017, the central bank also brought in, as part of minimum requirements for new issue and surveillance reports on covered bond programmes, a requirement that they contain “the asset-liability profile, including the maturity type of the covered bonds, e.g. hard bullet, soft bullet, or pass-through, the weighted average life of the covered bonds and of the cover pool and information on interest rate and currency mismatches”.

Market participants spoken to by The CBR said that to their knowledge it is the first time that details of a covered bond’s maturity structure have been a documented factor in the ECB’s collateral framework, with the still-to-be-announced plan on different haircuts for soft bullets and CPTs an important move.

“It’s still a very early stage,” said an analyst, “but it’s interesting that they react on this.”

Soft bullet structures have become the norm in most jurisdictions and conditional pass-through (CPT) issuance has taken off since NIBC launched the first such legislative benchmark in October 2013, while their pricing differential versus hard bullets has become minimal. Extendible maturity structures have meanwhile become an increasing feature of legislation in countries such as Denmark and Poland, while Germany is considering joining the trend.

However, the ECB has on several occasions appeared to be concerned at the potential risks of such developments. For example, in its response to the European Commission’s harmonisation consultation in January, the ECB said the appropriateness of preferential risk weight treatment for covered bonds should be monitored on an ongoing basis “including in the light of continuous innovation within the covered bond asset class, like, for example, a more pronounced usage of non-standard amortisation structures, such as conditional pass-through covered bonds”.

The ECB in 2013 introduced higher haircuts for own-use covered bonds and the analyst said that the common use of extendible maturity structures, often CPTs for peripheral issuers, could have contributed to the central bank’s decision. A DCM banker meanwhile cited the lack of standardisation in CPT structures, notably around issuer discretion.

Among the other measures announced today and that will become effective on 1 January is the introduction of graduated haircuts for eligible asset-backed securities (ABS) based on their weighted average life (WAL) as calculated from expected cashflows, while it will alongside the covered bond move next year introduce graduated haircuts depending on remaining maturity also for floating rate assets, which are currently assigned a flat haircut irrespective of their maturities.