The European Commission has invited the EBA to give recommendations on key aspects of the potential features, regulatory treatment and encumbrance impact of European Secured Notes (ESNs), including its view on the transferability of covered bond best practices to the mooted asset class.

The Commission announced on 8 June that it will assess the case for developing ESNs – a covered bond-style, SME-backed product proposed by the European Covered Bond Council (ECBC) – for the financing of SME and infrastructure loans.

The announcement was made in a mid-term review of the Commission’s Capital Markets Union (CMU) project, in which it was also announced that the Commission is to propose a harmonised EU covered bond framework. This decision was informed by recommendations from the European Banking Authority (EBA), which had earlier identified best practices in the covered bond market.

In a letter addressed to EBA chairperson Andria Enria and dated 3 October, Olivier Guersent, director-general, Financial Stability, Financial Services and Capital Markets Union, invited EBA to build on its work with respect to covered bonds and assess three aspects:

• “The extent to which these best practices for covered bonds could be applicable on a mutatis mutandis basis to ESNs,
• “The appropriate risk treatment of ESNs in light of their features and expected risk-return profile,
• “The effects ESNs could have on individual banks in terms of asset encumbrance impact on unsecured bank creditors.”

The Commission stressed that as SME bank loans and infrastructure bank loans are fundamentally different, each best practice for covered bonds should be analysed separately for ESNs backed by the two forms of collateral.

The Commission noted that in order to complete the ESN feasibility assessment by its deadline of the second quarter of 2018, it would need to receive EBA’s final report by 30 April 2018.

Guersent said the ESN asset class aims to cover a funding segment located between traditional covered bonds and STS securitisations.

“It could increase the variety of funding tools available to banks unlocking more financing for SMEs and infrastructure projects, and contributing to economic growth and investment,” he said.

Luca Bertalot, secretary general of the EMF-ECBC, said the industry body’s ESN taskforce is working closely with EBA.

“We are glad EBA, who have already done excellent work on covered bonds, will be assessing ESNs,” he added. “The deadline is quite short in our view, but EBA has all the ammunition it needs to provide a good answer to the Commission.

“We also think it is positive that the ESN is also under scrutiny by the Commission and has already been analysed by the European Parliament, so there is a cross-institutional interest in the topic.”

The Commission has also held a tender for a separate study exploring the feasibility of ESNs. It is understood to be currently considering the offers received.

Photo: Valdis Dombrovskis and Jyrki Katainen announcing the Commission plans; Copyright: EU