Utopia? Dystopia? Either way, harmonisation of covered bonds has often been dismissed, but at a recent vdp conference in Copenhagen delegates heard calls for the industry to at least give it some consideration, with reassurances given to address fears about a loss of quality.

Bruegel’s Tower of Babel

Harmonisation has become a recurring and increasingly frequent topic in covered bonds in recent years as the asset class has expanded, in terms of geography, collateral type, and/or repayment structure, and the industry is sensitive to comments from regulatory sources about greater standardisation being necessary for preferential treatment.

At the 17th Central European Covered Bond Conference hosted by the Association of Danish Mortgage Banks (Realkreditrådet) and the Association of German Pfandbrief Banks (vdp) in Copenhagen at the end of October, Wolfgang Kälberer, head of the vdp’s Brussels office, noted three different backgrounds to the topic of harmonisation of covered bonds in the European Union: the Capital Requirements Regulation (CRR), pronouncements by the European Systemic Risk Board (ESRB), and a European Commission Green Paper on long term financing of the European economy.

Under the CRR, the European Banking Authority (EBA) is conducting a review of the core elements of covered bonds, and the ESRB in December 2012 recommended that national supervisory authorities “identify best practices regarding covered bonds and encourage harmonisation of their national frameworks”.

Kälberer said the EC green paper poses the biggest challenge of these three initiatives because of the pressure from it to expand the type of assets backing covered bonds, and that there is a risk of losing preferential treatment if the asset class is not ring-fenced somehow.

He and other panellists at the conference argued that the time had come for the covered bond industry to take a more positive stance on principles-based harmonisation, for the longer term benefit of the asset class.

He and Pontus Åberg, senior economist, European Central Bank, acknowledged industry concerns and scepticism about full harmonisation, for example that it would lead to a loss of quality, stifle competition and “innocent” innovation, and/or is unrealistic.

However, Kälberer and Åberg said that there are many potential benefits and that the covered bond industry should give harmonisation a chance.

“These questions shouldn’t stop us from starting with the exercise,” said Åberg.

Exploring common legislation would be a big and serious exercise (“none of this is trivial”) and different stakeholders’ voices would need to be heard and the costs and benefits carefully weighed up, he said, but this is “not an argument not to start a non-binding exercise about how this would look like”.

In a similar vein, Kälberer acknowledged industry fears about harmonisation but sought to reassure, noting that it is a long term project and “must be to add value and not destroy it”.

To achieve this, it should be tailor-made and principle-based instead of full harmonisation of all technical features of each system, he added.

Harmonisation would bring benefits for covered bonds from the perspective of their regulatory treatment, according to Kälberer. For example, he said that when it comes to EU trilogue negotiations a lack of harmonisation is to the detriment of covered bonds. In discussions in the European Parliament two questions are inevitably always raised, he added: “What is a covered bond?” and “Why don’t you go for harmonisation?”

“We are constantly under pressure to explain the mechanics,” he said. “Harmonisation would facilitate policy messages.”

Jens Valdemar Krenchel, head of Brussels office at the Association of Danish Mortgage Banks, put it thus: “If you want preferential treatment you should at least be able to explain what you want preferential treatment for.”

Breaking it down

Kälberer and Åberg each identified four areas where there could be scope for harmonisation.

Emphasising that the approach should be principles-based, Kälberer cited: eligible assets, special public supervision, transparency, and bankruptcy remoteness.

With respect to special public supervision, for example, he said that there is a very diverse interpretation of what that constitutes and that there are “good reasons to draft common principles about special public supervision”. Similarly, there is room for some common principles about asset segregation even though rules about bankruptcy remoteness are also quite divergent at the moment.

Åberg in turn said that the approach should be “top-down” and that there are four areas that could be the starting point for a harmonisation exercise: definitions for measuring cover pool quality, such as property valuations and LTV ratios; eligible underlying assets; common practices of cover pool supervision; and transparency of cover pools, issuers, and legal features.

He stressed that any harmonisation exercise would not be about minimum targets but that it would be important to have “a more ambitious first target” and aim for some common standards.