Retained soft bullet and especially conditional pass-through covered bonds face harsher treatment under long-awaited changes to the ECB’s collateral framework announced today (Thursday), with haircuts on the extendible maturity structures to be based on maximum legal maturities.

The European Central Bank announced in November 2016 that it planned to adjust the haircuts it applies to retained soft bullet and CPT covered bonds in its collateral framework to reflect “additional risks”. The unveiling of the new rules had originally been due by the end of 2017, but was delayed.

Among amendments to Article 3 of Guideline (EU) 2016/65 (ECB/2015/35) announced today, the ECB states that for marketable assets allocated to haircut categories I to IV – UCITS-compliant “jumbo” covered bonds are included in haircut category II and other covered bonds in haircut category III – the applicable valuation haircut will depend on the residual maturity and coupon structure of the asset.

It continues that:

“The residual maturity for own-use covered bonds shall be defined as the maximum legal maturity, taking into account any extension rights for principal repayments contained in their terms and conditions.”

Market participants spoken to by The CBR have interpreted the ruling as meaning that a five year soft bullet covered bond with the option of a one year maturity extension will be treated as having a residual maturity of six years, while a five year conditional pass-through (CPT) covered bond that can be extended by 30 years will be treated as having a residual maturity of 35 years. This could result in a doubling of haircuts for some CPTs.

The action is not the first from the ECB to discriminate against extendible maturity covered bonds. As of 1 February, covered bonds that have a CPT structure and are issued by an entity with a first-best issuer rating below CQS3 became ineligible for purchase under the ECB’s third covered bond purchase programme (CBPP3).

“I don’t think the new haircuts will have a huge effect, but the signal from the ECB is not positive for the conditional pass-through structure,” said an analyst. “I don’t agree with the ECB’s treatment of these covered bonds.”

The new rules must by applied by Eurozone central banks from 16 April.

We plan to bring you further analysis of the ECB’s moves tomorrow.