The European Central Bank doubled down on its resistance to conditional pass-through covered bonds by yesterday (Thursday) excluding them from reinvestments of APP principal payments from 1 January, in an unanticipated move deemed “unfair” by some market participants, including the ECBC.

Announcing technical parameters for reinvestments of principal payments from maturing securities purchased under its asset purchase programme (APP), the ECB said: “With regards to CBPP3, the Governing Council also clarified that all CBPP3-eligible covered bonds with a conditional pass-through (CPT) structure will be excluded from purchase as of 1 January 2019.”

The ECB has for several years suggested there are additional risks inherent in CPT structures. For example, as of 1 February CPT issues from sub-investment grade issuers became ineligible for CBPP3 and later that month the ECB introduced new haircuts to its collateral framework whereby CPTs face harsher treatment based on their maximum legal maturities.

The latest, surprise move yesterday was seen by market participants as adding to the “increasingly negative attitude” of the ECB, in the words of Commerzbank analysts, who suggested Dutch CPT spreads would be the most affected.

The ECB’s position appears to clash with those adopted by parties to the Trilogue that is set to finalise the covered bond harmonisation package in time for a Directive and amendments to the CRR to be adopted by April. Bernd Lucke, Rapporteur of the European Parliament’s ECON committee, had proposed an amendment whereby covered bonds would face higher risk weightings the longer their possible maturity extensions, but this was ultimately voted down. The European Banking Authority (EBA) could ultimately be given a mandate to consider harmonisation of appropriate extension triggers and also report on whether there are any additional risks that need to be taken into account.

Joost Beaumont, senior fixed income strategist at ABN Amro, said the move ECB’s exclusion of CPT covered bonds from APP reinvestments is “unfair and out of line with other (upcoming) regulation”.

“Overall, the ECB has often taken a negative stance towards CPT covered bonds, which in our view primarily stems from the fact that it does not favour to buy CPT covered bonds from issuers that mainly benefit from the higher ratings that CPT structures offer, when compared to soft bullet or hard bullet structures,” he said. “Although one cannot deny this argument, it is a rather short-sighted perspective in our view, especially when looking at Dutch CPT covered bonds.”

Luca Bertalot, secretary general of the European Mortgage Federation-European Covered bond Council (EMF-ECBC), said the industry is not happy with the move.

“Of course we respect that this is a decision of the ECB,” he told The CBR, “but we don’t understand their negativity towards conditional pass-throughs.

“We remain convinced that it’s an important feature to allow covered bonds to improve resilience in the different capital markets of the Union, particularly in southern Europe but also in countries such as the Netherlands that have taken it up. And it offers an element of transparency for investors.”

The ECB’s move against CPTs should in itself have no more than a modest negative impact on their performance, said Maureen Schuller, head of financials research at ING.

“However, the stream of decisions from the ECB, but also earlier discussions on the covered bond Directive, do make investors uncertain and potential new issuers reluctant to enter this market, not knowing what further regulatory negatives may be on the cards next,” she added. “As such, further in-depth analysis, as also approved by the ECON recently, that either confirms or refutes the perceived higher risks of CPT covered bonds, is crucial for this market segment.”

According to Schuller, Dutch covered bonds’ primary allocations to central banks and SSAs, which would have captured any CBPP3 purchases, had already been lower for CPTs than for bullet covered bonds.

“This suggest CPT covered bonds already benefit less than bullet covered bonds from the CBPP3.”

The parameters of the ECB’s planned reinvestments were otherwise as expected.

“Reinvestments will be made in the same programme, will be handled flexibly over time and will continue to be driven by the market capitalisation of the individual covered bond countries (not by the origin of the maturing bonds),” Commerzbank’s analysts summarised.

Analysts noted the ECB said primary market purchases will “continue to be permitted as necessary”, confirming the Eurosystem’s ongoing presence in new issues after it gradually reduced its presence this year.