European Commission harmonisation proposals are welcome but lack bite or detail in crucial areas, the ICMA Covered Bond Investor Council told The CBR, citing concerns over areas including asset eligibility, maturity extensions, and the potential loss of transparency progress.

The harmonisation Directive and associated Regulation, published on 12 March, proposed a common definition of covered bonds and defining the features of and rules applying to covered bonds seeking to use a new “European Covered Bond” label.

In a response to the proposals, the Covered Bond Investor Council (CBIC) welcomes the legislative package – despite some past concern over its necessity – in particular highlighting that investors appreciate that the framework will support the introduction of covered bond laws in new countries.

However, the CBIC has outlined a series of suggested changes, highlighting a number of areas in which investors deem the legislative package to be insufficiently stringent or lacking in detail.

“I completely understand how the Commission ended up where they ended up,” Patrik Karlsson, director, market practice and regulatory policy, ICMA, told The CBR. “They really have taken into account all the national specificities, and then gave as much flexibility as possible to allow member state frameworks to stay in place.

“But this is problematic for investors, who now just see one European framework – they no longer expect to differentiate between national frameworks, and so on. So some parts of the text look weak to us, and that is why we are asking for some strengthening of certain elements.”

The proposed Directive, as part of its rules on what can constitute a covered bond, requires that covered bonds are collateralised by high quality assets referred to in points (a) to (g) of Article 129(1) of Regulation (EU) No 575/2013 or by “other high quality assets” that meet certain requirements.

The CBIC say this definition is too loose and are insufficient for investors, who need certainty on the high quality of the eligible assets in the cover pool.

“Almost everyone is concerned about this reference to ‘other high quality assets’ in the cover pool,” said Karlsson. “It is far too vague.”

The CBIC therefore suggests that the legislation is amended to give the European Banking Authority (EBA) a role in providing clarity on the definition of “other high quality assets”, noting similar work the EBA has carried out in creating criteria for simple, transparent and standardised (STS) securitisations.

“We believe that empowering the EBA to draft guidance on high quality assets other than Article 129 assets, and reviewing that guidance every five years, would help investor certainty about the quality of European covered bonds,” said the CBIC. “Such guidance could, for instance, include specific reference to the loans to public undertakings if the EBA decided to include them in the list of ‘other high quality assets’.”

Member states are also permitted under the proposals to set standards on what represents a “sufficient level of homogeneity” in cover pools. The CBIC also suggests the EBA provide guidance on minimum standards in this regard.

As had been expected, the proposed Directive rules that any maturity extension of soft bullet and conditional pass-through (CPT) covered bonds cannot be triggered at the issuer’s discretion and must be regulated by law or contract. This is less stringent than a proposal put forward by the EBA in its recommendations to the Commission, in which it suggested the event of default be a condition for maturity extension.

The CBIC is concerned that the EBA’s proposal has not been adopted and said the current wording is too weak, offering insufficient protection to investors.

“Technically speaking, an issuer could call their regulator and say ‘tell us to trigger this’,” said Karlsson. “The regulator could then do so and it wouldn’t be at the discretion of the issuer, formally at least.

“That is the kind of scenario we are worried about.”

In the area of transparency, the CBIC expressed concern that the Commission’s principles-based approach could allow a weakening of current standards. It noted that investors have worked with issuers through the European Covered Bond Council (ECBC) for many years to help establish the Harmonised Transparency Template (HTT), and Karlsson said concern had been expressed that this progress could be lost.

“We want to make sure issuers don’t go backwards,” he said.

The CBIC added that investors appreciate disclosures offered by the HTT.

“Therefore, while retaining the principles-based approach in the Directive is fine, we believe there is scope to refer to industry initiatives in the recitals to keep the HTT in mind as a high standard of transparency that investors appreciate,” said Karlsson.

Among amendments to the CRR, the legislative proposal includes the introduction of a new minimum OC requirement of 2% or 5%, depending on the assets’ valuation model.

The CBIC welcomed the introduction of a 5% minimum, but said the proposals introduce the potential for confusion by allowing various calculation methods that could result in lower nominal OC levels.

“The proposals are too complex and hard to grasp for a regulatory regime that wants to harmonise and make things more transparent,” it said. “We believe a clearer way to achieve harmonisation would be to allow the different methods of calculation but to not allow OC levels lower than 5% based on the nominal principle.”

The Directive provides for the Commission, in 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.

The CBIC welcomed the intention, but said the time period proposed is too long, noting that practical equivalence steps would take longer still and that investors would not be able to achieve capital benefit from investing in third country covered bonds even if the regime is equivalent to the European one.

Therefore, the CBIC proposes to reduce the deadline for the report to two years and suggests the EBA start the process by submitting a report to the Commission one year after application to help design the technical framework for equivalence assessments.

“Our members would benefit from the ability to diversify their investments better if an appropriate alignment of risk and prudential treatment was available for third country frameworks,” it added.

The CBIC said a proposal to allow for intragroup covered bond funding – via the use of internal covered bonds issued by a credit institution as collateral for the external issue of covered bonds by another institution in the same group – could also help promote covered bonds among smaller issuers.

However, it said a minimum rating requirement of AA- for the issuer of the internal covered bonds in addition to the external covered bond could limit the use of this model in countries where it may be most useful.

“We would propose to remove the minimum rating requirement for the internal covered bond,” it said. “However, investors in the internal covered bond should have explicit recourse to the external covered bond issuing institution.”

The CBIC also proposes that the EBA provide minimum guidance on the minimum criteria for the roles and duties of cover pool monitors, and suggested that greater detail be provided on a proposed 180 day liquidity buffer, again proposing the EBA provide some guidance – with Karlsson noting that the current proposals are “quite woolly”.

The CBIC plans to release its full response shortly.