A study commissioned to weigh the pros and cons of covered bond harmonisation has concluded it could have clear net benefits, with a “conservative” estimate putting this at Eu7.5bn, confirming the likelihood of the European Commission next month announcing plans for a Directive.

The report by consultancy ICF and led by covered bond veteran Richard Kemmish was commissioned by the European Commission as a key contribution to its considerations regarding what action, if any, it should take towards harmonising EU covered bonds.

The report (Covered bonds in the European Union: Harmonisation of legal frameworks and market behaviours), online today (Friday), finds that the overall benefits of potential EU legislative action, as discussed in the study, “are clear”. It says such action can (in its words):

• Reduce the vulnerability of the asset class to future market risks and vulnerabilities;
• Improve investor confidence in the asset class, as indicated by the responses to the survey;
• Help to safeguard the existing prudential treatment;
• Contribute to the objectives of capital markets union, in particular by better linking the capital markets to economic needs.

“Whereas it is impossible to quantify the benefits of EU action meaningfully,” it says, “it is clear that the benefit of increasing investor confidence alone would far outweigh any costs identified in the following section. An improvement in investor confidence will presumably yield ‘multiple basis points’ of savings.”

“Given the above value sensitivity analysis for the entire market of Eu1.5bn per basis point, a reduction in risk equivalent to a 5bp improvement in pricing would generate a total benefit of Eu7.5bn. As 5bp is a relatively conservative estimate of the potential benefit, this seems a self-evident justification for legislative action.”

The calculations are based on the assumption that a one basis point movement in investor yield represents a Eu1.5bn change for the overall value of existing covered bonds.

The study also reviews the three-step approach to harmonisation proposed by the European Banking Authority in a report to the Commission in December. It agrees that in many of the EBA’s proposals there is a clear case for action.

“In most cases, the upfront costs of the proposals or ‘contingent’ costs such as the loss of future flexibility are insignificant,” it says. “Their benefits on the other hand are potentially significant but generally difficult to quantify.”

However, the report raises issue on six points: coverage requirements; liquidity risk mitigants; disclosure; conditions for soft bullets and CPTs; eligible cover assets; and transitional arrangements.

The full report can be found by clicking here.

An online survey of issuers and national coordinators that received 61 responses and 56 stakeholder interviews were among the research that contributed the evidence base for the study.

The report notes that the views it includes are those of the authors – Richard Kemmish, Charu Wilkinson and Oskar Andruszkiewicz – and do not necessarily reflect the official opinion of the Commission.

The Commission is expected to announce plans for a Directive in early June, when it gives a mid-term update on its wide Capital Markets Union (CMU) project, with a proposal then potentially coming out early next year.

Didier Millerot, head of unit, banks and financial conglomerates, DG FISMA, European Commission, indicated that the study would confirm the benefits of a legislative action to harmonise covered bonds at a European Covered Bond Council plenary in April.

Photo: Richard Kemmish (speaking); Credit: ECBC, Itaka Media