A renewed effort to reform and unify Austria’s covered bond framework is expected to deliver a draft law in early 2019, with market participants optimistic the project will succeed where others failed as Austria’s new government and the EU Directive add impetus.

On Thursday of last week (2 August), the Austrian Economic Chamber (WKÖ) announced – not for the first time – that the bank and insurance division of the WKÖ and stakeholders including five banking associations and representatives of major banks and institutions authorised to issue covered bonds have agreed to revise Austria’s legal covered bond framework, to be in a “cleaner and more coherent state”.

The overhaul of Austria’s complex covered bond framework – which comprises three distinct laws used by different issuers – has been discussed and aspired to for many years, but previous efforts to create a unified law have stalled.

The WKÖ and the aforementioned stakeholders announced a collaboration in April 2017 to develop proposals for a unified law with a view to implementation by 1 January 2018. In its announcement last week, WKÖ said these proposals were submitted to the ministry of finance in 2017 – but no draft law emerged.

Now, the WKÖ said a draft law will be published in early 2019, incorporating the legal proposals from the European Commission for a harmonised EU covered bond framework.

“Fortunately, the Austrian government acknowledged the modernisation of capital markets law and in particular the complete overhaul of the Austrian Pfandbriefgesetz in its government programme (2017-2022),” said the WKÖ. “Finance Minister Löger has announced to prepare a draft law which will take into account the standards of the final European legislation.

“The draft law has been held out in prospect for the beginning of 2019, after the Austrian EU Council Presidency.”

The WKÖ added that the Austrian banking industry welcomes the proposed covered bond Directive.

“By this means, the already historically successful product can be strengthened in a European context,” it said. “The Austrian banking industry wants to maintain the high market standard of covered bonds in Austria in view of the EU proposals.”

Despite previous disappointments, market participants and observers are confident that the draft law will be published on schedule.

“Our new government has put the new covered bond law on its priority list,” Katarzyna Kapeller of the Pfandbrief & Covered Bond Forum Austria told The CBR. “That makes me optimistic that the timeline will hold.”

In a sector comment published on Wednesday, Moody’s struck a similar note.

“Although an attempt in 2017 to align the three Austrian covered bond laws failed, we believe this latest effort will be successful,” said Martin Rast, vice president and senior credit officer at Moody’s. “The upcoming EU directive requires the authorities in all EU countries with covered bond laws to revisit their legal frameworks and align them with the directive.

“The EU framework is likely to be agreed and enacted in early 2019, followed by a one year implementation period into national law.”

Reform would be credit positive, says Moody’s

Under the current Austrian framework, different types of Austrian financial institutions issue covered bonds under one of three pieces of covered bond legislation, which, while strongly aligned, differ on aspects such as OC levels and LTV ratios. The three are: the Mortgage Bank Act (Hypothekenbankgesetz), used by Erste Group and UniCredit Bank Austria; the Law Regarding Secured Bank Bonds (Gesetz betreffend fundierte Bankschuldverschreibungen), used by cooperatives; and the Pfandbrief Act (Pfandbriefgesetz), used by Landeshypothekenbanken.

Moody’s believe the legislative changes will be credit positive for Austrian covered bonds, especially as they will address the fragmentation of the current legal framework.

Aligning the legislation with EU market standards would be credit positive in several aspects, said the rating agency, because it would lead to numerous improvements in areas where the current framework is weaker than minimum requirements proposed by the Commission.

It said, for example, that the Commission proposes a minimum overcollateralisation requirement of 5%, whereas in Austria the minimum depends on which of the three laws governs the programme and varies between zero and 2%.

Mirroring the language of its 2017 announcement, the WKÖ said the key points of the new legislation should be that all credit institutions that meet the legal requirements should have the option of issuing covered bonds, and that any European specifications should be taken into consideration. It added that “the liquidity aspect” and “procedural issues” should be taken into account.

Moody’s said legal requirements on the provision of liquidity and to account for issuer resolution scenarios under the Banken Sanierungs- und Abwicklungsgesetz (BaSAG), Austria’s implementation of BRRD, would reduce liquidity and operational risks and increase the likelihood of timely payments under covered bonds, if implemented appropriately.

The rating agency added that updating the legal framework also offers an opportunity to standardise provisions that some banks have introduced on a contractual basis. It noted that, in contrast to other significant covered bond markets, Austria’s legal framework does not include structural features addressing liquidity risks, similar to the 180 day liquidity buffer introduced in France and Germany and proposed in the Directive.

“Furthermore, the WKO’s announcement indicates that covered bond issuers want to maintain market characteristics that distinguish Austrian covered bonds in a credit positive way from other covered bond markets,” said Rast. “We understand that the legislation’s intention is not to lower the standards of Austria’s covered bond frameworks to the minimum requirements of the EU framework in areas where Austrian legislation or market practice provides a higher degree of protection.

“This is likely to include the current leverage limit of 60% of the property value for residential properties, which would provide more protection than the 80% limit of the EU framework. A lower leverage limit is credit positive because it implies that covered bonds backed by such loans are likely to exhibit good recovery value if property values decline significantly.”

Photo: Austrian Economic Chamber (WKÖ)