EMF-ECBC secretary general Luca Bertalot and others questioned the appetite for pressing ahead with EBA recommendations that might only deliver marginal gains during an S&P webinar last week, but talked up the potential rewards of working towards third country equivalence.

The webinar on the credit and market implications of the European Banking Authority report was hosted by Andrew South, head of structured finance research – EMEA, S&P Global Ratings, on Wednesday.

Although participants paid tribute to the thoroughness of the EBA’s work, Bertalot (pictured), secretary general of the European Mortgage Federation-European Covered Bond Council, highlighted that the mood in Brussels has changed since the regulator’s work was first commissioned.

He said there is little evidence yet in the European Commission or the industry of any enthusiasm for taking up the majority of the EBA recommendations to amend the covered bond directive.

“If you are in the corridors of the Commission, the only word that you hear is ‘simplification’,” he said, “and my question is, what will be its appetite for reopening Pandora’s Box when the EBA is saying that covered bonds are extremely important for the union and are working very well, with a need of only minor improvement to this market?

“We are collecting feedback from them and a lot of critical points have already been raised,” he added. “As an industry, we will be making sure that the good covered bond directive will not be the subject of overengineering.”

Bertalot noted that the directive has a principles-based approach potentially offering flexibility to include other asset classes, something that the EBA recommendations to align the directive with the CRR requirements would contradict, and Patrick Seifert, global head of corporates and DCM, LBBW, echoed these sentiments.

“The marginal benefits to be expected from this versus the work you put into it would be very, very limited,” he said. “This market is rock solid, basically triple-A by nature in a world where there are only nine triple-A countries left.

“And in whatever fine-tuning is done, we certainly want to be mindful of what’s happening in other dimensions and the broader context – we need room for manoeuvre for the market to serve the multiple challenges we face going forward, such as defence, and deregulation in the US.”

Antonio Farina, sector lead, covered bonds, S&P, noted that while several aspects of the EBA’s recommendations are “mildly” credit positive – subject to how they might be fleshed out and implemented – they would not materially change the way the rating agency looks at covered bonds. For example, while a tightening up of liquidity safeguards in Sweden could decrease the required overcollateralisation for currently assigned ratings, the jurisdiction is already a triple-A market.

Olaf Pimper, portfolio manager, Commerzbank, said that while he has welcomed the benefits of the directive – notably the European Covered Bond (Premium) tag, which would become the only available designation under the EBA recommendations – the most important topic going forward is that of third country equivalence. He said this poses threats as well as opportunities, but that overall the ability to diversify portfolios would be most welcome.

“Right now, we have a lot of uncertainty in the market towards third country equivalence,” he said. “If you take it seriously, then we as an investor have to ourselves do an ISIN by ISIN assessment of each covered bond, and that poses a lot of challenges. If we would have a third country equivalence list, then that would definitely be a game-changer.

“Not so much when it comes to LCR treatment; what would be of utmost importance is the risk weight assigned to those third country covered bonds – it would be lowered, for those banks using the standardised approach, from 20% to 10%, and for those using any kind of internal ratings-based approach, the impact might be even greater, because we would then be able to use a loss given default of 11.25% as for EU covered bonds, instead of the 45% that we were recommended by the EBA to use right now.

“So if a country indeed got on the third country equivalence list, I am very, very positive that there would be increased demand, at least by bank accounts – although there’s also a risk that if a country does not get on that list, you would see far less demand for their bonds, because banks would probably not buy them anymore if they are not LCR-eligible.”

However, the speakers flagged that the road to third country equivalence is set to be a long one.

According to Maureen Schuller, head of financials sector strategy, ING, none of the six major non-EU/EEA markets with euro benchmark covered bonds outstanding – Australia, Canada, New Zealand, Singapore, South Korea and the UK – would even satisfy the EBA’s prerequisites for third country equivalence assessment. She cited shortcomings related to supervisory equivalence, domestic investor involvement, and central bank and regulatory treatment, among others as disqualifying the jurisdictions from third country equivalence.

“And this is just the prerequisites,” said Schuller, “not even moving on to the other requirements to be considered once the equivalence assessment can actually be started.”

Bertalot suggested that any Brussels process towards a third country equivalence regime could be a journey of three to five years, but he said this would give the market the opportunity to overcome some of the challenges cited by Schuller and ultimately arrive in a stronger position.

“So the ECBC is, firstly, discussing and analysing all the covered bond legislation around the globe to try to make sure that they are as aligned as possible to the directive,” said Bertalot. “Then we are focusing on making sure that the treatment of covered bonds is harmonised around the globe.

“We need to make sure that all our partner countries who would like to have third country equivalence should have recognition of covered bonds in the LCR and in the assets repo-eligible with their national central bank. So we have started lobbying with all the ministers of finance and central banks outside the EU to make sure that we have covered bonds in Level 2 of the LCR, but even in Level 1, where we have them in Europe.

“If we convince the other countries to put covered bonds in Level 1 and secure reciprocity,” he added, “we will build probably the largest investor base that we can have for one of the most important asset classes of the Union. And the housing agenda will benefit massively from having an active, robust and global covered bond market.”

A replay of the webinar can be found here.