The risk weight applicable to European Covered Bonds (Premium) under the Standardised Approach could fall from 10% to 5% under amendments put forward in a draft ECON report, with covered bond proponents keen for the instrument to retain its favoured status versus securitisation.

Under EU moves to improve the securitisation market, the risk weight for the highest quality securitisations would fall to 5% on a comparable basis, thereby reversing the long-standing preferential treatment of covered bonds.

In two draft reports dated last Thursday (11 December), German MEP Ralf Seekatz (EPP) (pictured), Rapporteur for the European Parliament’s Economic & Monetary Affairs Committee (ECON), included amendments to commensurately improve covered bonds’ treatment – with the risk weight of covered bonds of credit quality step 1 cut from 10% to 5% – and to explain the rationale for doing so:

“To ensure coherence in the prudential framework following the recalibration of capital requirements for high quality securitisations, the treatment of covered bonds should be adjusted accordingly. Covered bonds exhibit a consistently robust risk profile due to their structural safeguards and regulatory framework. Maintaining an appropriate balance between the prudential treatment of covered bonds and securitisations is necessary to avoid unintended market distortions and to preserve the functioning of the covered bond market as a key source of stable funding.”

The move – which would involve modifying the Capital Requirements Regulation – has been welcomed by proponents of covered bonds, who had been pushing for such a response.

“We are very pleased,” Luca Bertalot, secretary general of the European Mortgage Federation-European Covered Bond Council (EMF-ECBC), told The CBR. “We are firm believers in the complementarity of the two instruments and support any initiative to reinforce and make the securitisation market a success in the Capital Markets Union.

“At the same time, we cannot risk any kind of arbitrage and it is very important to ensure that covered bonds retain their status as a very attractive instrument.”

However, such a lowering of risk weights would not simply maintain EU/EEA covered bonds’ position in credit markets, but give them a boost, according to market participants.

“It would make covered bonds meaningfully more attractive to the key bank treasury investor base,” said Cas Bonsema, senior financials analyst at Rabobank. “In our view, EEA covered bond spreads would tighten in across the board as capital requirements decrease.

“As a result, covered bond spreads would be expected to trade closer to those for government bonds (0% RW) and SSAs.”

The proposed lowering of risk weights could nevertheless amplify the differential between EU/EEA covered bonds and those from third countries, which would not see any improvement to their already higher risk weights – only emphasising the importance of EBA third country equivalence proposals.

The draft reports will be discussed within ECON before being finalised with possible further amendments, ahead of the EU trilogue process in the new year, so any finalisation of the securitisation package is not expected until towards the end of the first half.