Concern over asset eligibility rules that are alleged to leave “enormous” room for dilution could prompt changes to the EC’s planned Directive, such as a list of permitted assets, according to DG FISMA’s Didier Millerot, who also discussed homogeneity and OC requirements.

Millerot, head of unit, banks and financial conglomerates, DG FISMA (pictured), was introducing the Commission’s proposed legislative package to harmonise EU covered bond laws at a European Covered Bond Council (ECBC) plenary in Vancouver on Wednesday. He noted that the package was aimed at giving sufficient flexibility to member states, but acknowledged concerns expressed by market participants about excessive room for interpretation on certain provisions.

Article 6 of the proposed Directive requires that covered bonds be collateralised by high quality assets referred to in CRR Article 129 or by “other high quality assets” that meet certain requirements.

Millerot said that on this point the Commission had sought to be as uncontroversial as possible, ensuring that assets that have been used as collateral can continue to be used, but conceded that further discussion and clarification may be required. He said that on this issue it was difficult to strike a balance between using a flexible approach and providing limits that market participants are comfortable with.

“We are probably reaching the limits of the logic of the principles-based approach here,” he said. “The challenge will be to identify an alternative to the principles-based approach.

“Perhaps one alternative is to forget about it, at least for this provision, and have a list instead, like we have already in the CRR Article 129.”

Millerot stressed that the Commission has no intention of using this aspect to introduce European Secured Notes (ESNs), a proposed covered bond-alike structure backed by alternative assets such as SME loans, and said any introduction of ESNs would be conducted parallel to the Commission’s work on covered bonds.

Under Article 10, the Directive also proposes that member states shall ensure investor protection by providing for a “sufficient level of homogeneity” for cover pool assets.

“It seems that some member states consider that this could create some problems in view of practices established in their countries,” said Millerot. “But we will need to see how this develops further.”

Market participants speaking on a panel discussion that followed Millerot’s introduction of the legislative package thanked and complimented the Commission for its work on the Directive.

Boudewijn Dierick, head of covered bond and ABS flow structuring at BNP Paribas and acting deputy chairman of the ECBC, summarized discussions that took place the previous day at a meeting of the ECBC’s steering committee, noting that feedback was overall positive and that the proposals contained no major surprises and should not disrupt functioning markets.

However, the panelists added that the Commission’s principles-based approach – which was, they noted, requested by the market – has resulted in the need for clarification in certain areas.

“Overall, we are super-happy with the proposal,” said Morten Bækmand Nielsen, head of investor relations at Nykredit and chairman of the ECBC technical issues working group, “but as always, there are nitty-gritty details that need to be looked at.”

Like Millerot, market participants highlighted the question of asset eligibility. Wolfgang Kälberer, department head, EU office, Brussels, at the Association of German Pfandbrief Banks (vdp), said there is “enormous room” for diluting the requirements on asset eligibility.

“We think Article 6 is not sufficiently secured against dilution, because high quality assets are not sufficiently defined and it gives room for interpretation – considerable room for interpretation – for member states,” he said.

The “loose” definition of eligible assets was also high among concerns raised by the ICMA Covered Bond Investor Council (CBIC) in its response to the Commission’s proposals.

Nykredit’s Nielsen cited concern about how the Article 10 requirement on homogeneity in cover pools could affect the Danish market.

“It is no secret that in Denmark we are very focused on creating large cover pools in order to issue very large bond issuances.” he said, “Therefore, one of our concerns is that we could no longer mix, for example, commercial real estate and residential mortgages in the same pool.”

Kälberer said the vdp’s suggestion would be to simply remove this Article.

“Why? Because we don’t see any discouraging developments in the market,” he said. “We haven’t seen any complaints from the market, from investors, that they are not happy with transparency on the composition of cover pools.”

He further questioned the need for such requirements, since “very expensive” disclosure requirements are already in place – citing national provisions and the Harmonised Transparency Template – providing investors a deep insight into the composition of cover pools.

Millerot said the general principle given on homogeneity is not intended to prevent the mixing of collateral, such as the example highlighted by Nielsen.

“We did not have in mind that we should not mix commercial and residential in the same pool,” he said. “It is more extreme situations that we would like to avoid, like mixing ships with Bavarian real estate mortgages, or something like that.”

He added that the Commission can be flexible on these points, but said it will be “more attentive” on the drafting of Article 6 than of Article 10.

In the Regulation element of the package, the Commission proposes the introduction of a new minimum OC requirement of 2% or 5%, depending on the assets’ valuation model. Analysts said this addition will be welcomed by certain markets, but the CBIC has said that the introduction of various calculation methods for OC could result in confusion.

Millerot noted the introduction of the 5% requirement was based on advice from the EBA.

“There is a flexibility clause that we introduced in this provision, but the key rule is the 5%,” he said.

The vdp’s Kälberer meanwhile welcomed that the Commission’s proposals do not include multiple EBA mandates.

“EBA mandates are technical standards, and this would be nothing less than full technical harmonisation,” he said. “If we were getting too many EBA mandates this is full harmonisation through the backdoor, which we wanted to avoid.”

Investors in the CBIC have suggested the EBA be given a role in defining what constitutes eligible assets and “sufficient” homogeneity in cover pools and in providing further guidance on certain aspects of the proposed requirements.

Luca Bertalot, secretary general of the EMF-ECBC, said the covered bond market must now work together to provide feedback to the Commission by its deadline on 10 May. He said the ECBC will ask representatives of every relevant country to identify four major challenges to their national market, in order of priority, and will combine this with an analysis provided by legal experts that form one of the ECBC’s working groups.

Photo credit: EMF-ECBC/Twitter