The European Central Bank yesterday (Tuesday) welcomed the European Banking Authority’s proposed three-step approach to covered bond harmonisation in a contribution to a consultation on the European Commission’s Capital Markets Union mid-term review.

The Commission’s CMU consultation ended on 17 March, but the ECB contribution is understood to have been submitted after the deadline and was only made available publicly yesterday.

In its response to the latest consultation, the ECB echoes themes it took up in its response to the Commission’s covered bond harmonisation consultation in January 2016.

“While EU covered bond markets are well functioning, with many long established national legal frameworks for covered bonds, they remain highly fragmented along national lines,” it says. “Consequently, the ECB favours a high-quality and transparent EU covered bond market, and sees potential for harmonisation of some standards and practices across the EU.

“Such an approach should be sufficiently cautious,” it adds, “and should avoid market distortions in a segment that proved to be relatively resilient throughout the financial crisis and for which a certain level of harmonisation across the specific national legal frameworks already exists.”

The ECB said it welcomes the EBA recommendations as a tool to achieve these two objectives.

“The three-stage approach proposed by the EBA recommendations is consistent with the ECB’s view that a comprehensive covered bond legal framework at EU level is achievable over a medium to long term horizon, following a harmonisation and convergence process.

Enhancements to the definition of covered bonds that receive a preferential capital treatment proposed by the EBA were cited by the ECB, with a proposed minimum coverage requirement “a highly desirable improvement”.

“As a common measurement of overcollateralisation, it would allow supervisors and investors to compare covered bonds more easily across Member States and issuers,” it said. “It should also ensure that all covered bonds eligible for the preferential capital treatment provide investors with an additional layer of safety.”

The ECB meanwhile reiterated previously stated concerns about innovations such as new maturity structures, including conditional pass-throughs.

“The rapid development of innovative covered bond structures, whose features are not yet fully understood by all stakeholders, requires careful assessment, to ensure a sustainable market development,” it said. “Over the past few years new covered bond structures in which the scheduled maturity of the outstanding bonds can be extended by the issuer have been increasingly used.

“While these structures present certain advantages to the issuers compared with the traditional bullet structures, and are generally positively assessed by investors as an additional protection against a default of the issuer, the specific risks posed by them have not been sufficiently assessed by the prudential supervisors.”