The EBA flagged the role of reciprocity for third country equivalence at an ECBC plenary on Wednesday, highlighting the importance of a PRA U-turn, but a German bank investor suggested that damage had already been done. Meanwhile, it will take a pass on ESNs.

Speaking at the latest European Mortgage Federation-European Covered Bond Council (EMF-ECBC) plenary in Athens, Roberta De Filippis, team leader, securitisation and covered bonds at the European Banking Authority (EBA), shared insights into the covered bond recommendations it is due to make to the European Commission this summer.

She cited reciprocity as one of four dimensions of any future EU equivalence regime.

“This will be based on reciprocity in cooperation with the third country authority,” said De Filippis.

Expectations that this would be the case was a factor the alarm sparked by a surprise Prudential Regulation Authority (PRA) move earlier this month to generally exclude non-UK covered bonds from UK banks’ LCRs by publishing a “modification by consent”.

Although the regulator on 17 April paused the process “to consider and address the points raised appropriately”, an EU-based bank investor’s answer to a question from The CBR as to whether the episode could make him more cautious in buying UK covered bonds suggested damage has already been done.

“The short answer is, yes,” responded Christopher Bergmann, head of liquidity portfolio management, treasury, DZ Bank, saying UK issuers have to pay up to reflect the risk in them, including potential “countermeasures” from the EU.

The timing of the PRA’s move had been seen by UK issuers as “particularly unfortunate”, coming during the EBA’s work on equivalence, according to Michael McCormick, head of head of FIG DCM at BMO.

“The silver lining to the whole incident is that it has galvanised the market around the product,” he said. “The product is important and while there are lots of different regulations coming through, with respect to Basel and other things, there needs to be a continued dialogue with the regulator on this point.

“And clearly the PRA has taken note and taken that feedback on board, and decided to pause. Going forward, the challenge for the market is to continue to engage with what the EU is doing, potentially after the EBA comes out with their process.”

McCormick noted that, in line with the Basel framework, Canadian and other third countries’ liquidity and capital regulations for covered bonds do not include issuer jurisdiction as a criteria.

“What will help the market grow internationally,” he added, “is if we all take the success of the initiatives that have been done through the ECBC for the EU, and try to extend that to other jurisdictions so that we get the right results in other markets.”

EBA state of play

The level of maturity of the third country covered bond market would be taken into account in conjunction with reciprocity, noted De Filippis

Alongside reciprocity, three further “dimensions” relating to third country equivalence were cited by De Filippis.

“Second, the scope, which is clearly the Covered Bond Directive. Third, the process to be followed for this equivalence assessment. And fourth, which is currently the main area of focus of the discussion, the principles upon which we should assess equivalence.

“And on this, we support a principles-based approach in the spirit of the Covered Bond Directive, that is necessary to assess different markets.”

On the EBA’s other covered bond work, she said the key areas under discussion with regards to its review of directive implementation are extendible maturities and liquidity buffers, and the topic of cover assets including the use of derivatives.

Regarding European Secured Notes (ESNs), which have long been touted as a dual recourse instrument backed by SME loans, the EBA will not support an update of the conclusion of its previous report due to the lack of market developments.

“We think it’s important, especially in light of the fact that securitisation is maybe not suitable for financing this asset class, so we remain open and we stand ready to react in case of new market activities,” added De Filippis.

“And we will try to reflect this positive approach in the report.”

The EBA is due to deliver its recommendations – also regarding green covered bonds – to the Commission in June, although there could be a slight delay until later in the summer, according to De Filippis.