The European Commission’s deferral of consideration of a third country equivalence regime could hinder progress in new markets and create uncertainties, market participants have warned, but a Commission official stressed the need for a sequenced approach.

The proposed covered bond Directive, published on 12 March, provides for the Commission, in close cooperation with the EBA, to assess whether a general equivalence regime for third country (i.e. non-EU/EEA) covered bond issuers and investors is “necessary or appropriate”. If deemed to be so, a legislative proposal will be submitted within three years of the adoption of the Directive.

Speaking at an ECBC plenary in Vancouver on 18 April, Millerot, head of unit, banks and financial conglomerates, DG FISMA, said the Commission did not include a third country equivalence regime in the proposal but instead included the review clause because it wanted to take a sequenced approach.

“First, what we wanted to do is negotiate the text, agree on a new European regime, have it implemented for a few years, and then see whether we could expand this approach to third country investors,” he said. “We thought it would be a bit premature to include these equivalence provisions already in the proposal.”

Responding to questions from the audience on how the Commission would approach the question of equivalence, Millerot (pictured) said it had decided to at first focus on making investments in the EU more attractive, a key part of its Capital Markets Union (CMU) agenda.

He said that there was also an ambition to ensure EU investors have access to a wider range of investments, including covered bonds issued by third country issuers, but noted granting capital relief for such investments would be a complex task – given that different classes of investor are governed by different legislations and given that non-EU/EEA covered bond frameworks would need to be analysed on a case by case basis.

He also noted the issue is “politically tainted” as the EU is set to shrink in the coming year.

“For all these reasons, we wanted to focus on getting the EU framework in place first,” he said.

Some market participants made their disappointment clear.

Loïc Chiquier, chief technical specialist in the finance and markets global practice, World Bank, said he would have liked a more compressed timetable, while discussing ways in which the global growth of covered bond markets can be supported.

“Doing this review three years after implementation puts us in 2023,” he said. “For some of the countries in the non-European zone, I’m not sure they can easily wait five or six years.”

Fritz Luithlen, head of debt capital markets at DZ Bank, said the Directive, together with the depth of the European investor base, provides “a great gravitational pull” towards the establishment of the proposed EU framework as a global standard.

“I’m a bit disappointed by the time we’ve given ourselves to look at the introduction of equivalence regimes because that would be a great catalyst for that gravitational pull to have a more dynamic effect,” he said.

Wojtek Niebrzydowski, vice president, treasury, at CIBC told The CBR he shares the view that the delay is disappointing.

“We fully understand and support the notion that a comprehensive review needs to be done before a conclusion regarding equivalency,” he said, “but to be clear at this time we are talking four jurisdictions – Australia, Canada, Singapore and New Zealand – where all the legal, legislative and regulatory documentation should be public and in English.”

Colin Chen, managing director and head of structured debt solutions at DBS Bank and chairman of the ECBC’s global issues working group, told The CBR that the industry and relevant stakeholders will work with the Commission’s articulated timeline and attempt to support the case for equivalence to be implemented.

“We are grateful for the fact that the Commission will consider and assess the case for general equivalence for third country covered bonds,” he added. “We need to ensure that third country covered bond issuers can work with the industry stakeholders, e.g. the EMF-ECBC, the Covered Bond Label, etc, to build on both harmonisation of and convergence with covered bond principles.”

Analysts said that in the longer term, the proposed review could result in an eventual improvement in the treatment of third country covered bonds in the EU that would be in line with that introduced in new Basel rules, announced at the end of December.

“In the end, it could imply that the risk weight of Canadian, Singaporean, and Australian covered bonds – among others – could drop to 10%, from 20% currently,” said Joost Beaumont, senior fixed income strategist at ABN Amro.

S&P said the lack of a third country regime in the short term will lead to uncertainties, not just for important issuing countries outside the EU such as Canada and Australia, but in the UK, assuming that the Directive is unlikely to have been transposed into national law by the March 2019 Brexit deadline.