The Spanish government on Wednesday updated its plans for transposing the EU covered bond directive – including raising minimum overcollateralisation from zero in a previous draft to 5% in its latest text, in a change deemed positive by Moody’s – while using an expedited legislative process.

Last week’s move follows the publication of a draft law on 25 June, which was followed by a consultation period.

Although a reduction from the high overcollateralisation (OC) levels seen in cédulas thus far had been seen as inevitable, a zero percent OC requirement for cédulas hipotecarias proposed in the draft had met with concern among market participants, even if other changes were seen as strengthening Spain’s framework.

A 5% minimum OC level is now included for cédulas. Although this is weaker than the current 25% for mortgage covered bonds and 43% for public sector and export finance covered bonds, the change from zero to 5% in the law is positive, according to José de Leon, senior vice president and manager in Moody’s covered bond group.

“Previously, there was a provision that further OC could be added through new laws, or contractually agreed to by the issuer,” he told The CBR. “Now, the legislator has made a cross-reference to CRR to impose a minimum statutory level in relation to mortgage, public sector and export finance cédulas.

“The law retains the possibility for issuers to commit to higher levels,” he added.

A 5% OC level is necessary for covered bonds to achieve the European Covered Bond (Premium) designation under the directive, although this can be achieved either through legislation or on a contractual basis.

De Leon noted that the 5% minimum OC in the new Spanish law does not apply to the country’s three types of static-pool secured bonds (bonos).

The new text also introduces a provision for liquidation in the event of an asset shortfall, something which had been absent from the previous draft. However, Moody’s said that the wording of the planned asset coverage test in the law – with assets having to be higher than OC, including “voluntary” and contractual OC, and the liquidity buffer – means there is a risk it will always be failed, given that all OC is arguably voluntary.

“This would effectively leave Spanish covered bonds with high acceleration risk compared to elsewhere,” said Jane Soldera, senior vice president at Moody’s. “As these provisions are very technical, we expect the market will hope for clearer confirmation of the legislative intention.”

Issuers will be required to update property valuations for mortgage loans at least annually, in line with EU requirement, and the new text builds on the draft by requiring that the valuation-driven part of LTVs be floored at the level it was upon entering the pool. Soldera said the flooring requirement is credit positive.

With Spain’s covered bond market experiencing the biggest upheaval in aligning with the EU directive, banking industry representatives had expressed concerns about hitting the 8 July 2022 implementation deadline.

The law has, however, been presented as a Royal Decree Law, an accelerated legislative process in Spain that could see it coming into force after 30 days, albeit subject to amendments and a potentially longer passage.

“This is likely due to the urgency to comply with the deadlines,” said de Leon, “and to give time for Spanish banks to start carrying out the changes necessary to comply with the law.”

The Royal Law Decree, in Spanish, is available here.