Danish and Luxembourg covered bonds that were threatened with exclusion from LCR buffers have been reprieved in the final version of an amendment to the regulation, which also provides an anticipated long term solution to the issue of overlap between LCRs and the covered bond directive.

Under a proposed amendment to liquidity coverage requirement regulation published in October 2020, LCR-eligibility would require that covered bonds fulfil Article 129 CRR for privileged capital treatment, whereas previously compliance with Article 52(4) of the UCITS directive was also sufficient.

This would have excluded covered bonds including Luxembourg lettres de gage (LdGs) and Danish Realkreditobligationer (ROs), as well as aircraft Pfandbriefe, and consultation respondents including the Luxembourg Bankers’ Association (ABBL) and Finance Denmark objected, arguing that covered bonds falling under the directive should be LCR-eligible.

The final commission published on Thursday of last week (10 February) text adopts this proposal, thereby “defusing” the issue, noted DZ Bank analyst Thorsten Euler.

The LCR regulation amendment also addresses the duplication of liquidity requirements that resulted from the introduction of a 180 day liquidity buffer under the covered bond directive on top of the 30 day LCR requirement. The directive provided member states a waiver whereby banks could be exempt from the first 30 days of the 180 day requirement. However, the LCR assets would not in that case be in the cover pool, weakening protection for covered bond holders.

“The amendment addresses this weakness,” said Fitch. “It increases covered bondholders’ liquidity protection in the event of ‘enforcement’ (when a bank defaults and covered bondholders start getting their payments from the cover pool), as it ensures that covered bond-related outflows under the LCR are covered by liquid assets in the cover pool.”

The rating agency noted that the amendment will benefit most those jurisdictions, such as Germany, where liquidity buffers are calculated on the basis of originally expected maturity dates, rather than extended maturity dates, since more of the liquid assets in the cover pool will count towards the LCR.

While the issue has been addressed as anticipated, the amendment goes beyond the draft published in October 2020 by also allowing non-mandatory but encumbered assets in the cover pool to exceptionally count towards LCR requirements if issuers are required to have their assets attached to the cover pool by national law. In its response to the consultation on that draft, Finance Denmark had said that “it should be clarified that all ‘non-mandatory overcollateralisation’ in covered bond programmes (according to Article 411(1)(6) in CRR2) is considered unencumbered” and Fitch noted the exception for Danish mortgage banks.

The rating agency said that, elsewhere, continuing to treat liquid assets in cover pools beyond those required for the next 30 days of programme outflows as encumbered could discourage issuers from holding additional liquid assets in the programme, limiting liquidity for covered bondholders.

The LCR regulation amendment will be final once published in the official journal of the EU shortly and come into force by 8 July to coincide with the deadline for directive implementation.