The definition of liquid assets in the EU for the purpose of liquidity buffers under Basel III is left to the European Banking Authority under CRD IV proposals released by the European Commission today (Wednesday).

Basel Committee on Banking Supervision proposals allowed covered bonds to be included in Liquidity Coverage Ratios (LCRs) as level two assets, which will be limited to up to 40% of these liquidity buffers and face a haircut of at least 15%. Government bonds are considered level one assets under Basel III and face no such limits, whereas covered bonds sit alongside high quality corporate bonds.

Michel Barnier

Covered bond supporters have lobbied for the asset class to be given treatment more comparable to government bonds, but in final Commission proposals for CRD IV released today by EU Commissioner Michel Barnier no final definition of what assets classes can be used as level one or level two assets is given. This decision is left to the EBA, with the regulator due to report by the end of 2013.

“For the LCR, a particular focus of the observation period will be set on the definition of liquid assets,” said the Commission. “EBA will test different criteria for measuring how liquid securities are under stressed market conditions.

“This will prepare the ground for a decision before 2015 that will ultimately determine the eligibility criteria for the two tiers of the liquidity buffer.”

Article 404 of part three of the Commission’s regulation proposal lists as liquid assets:

• Cash and deposits held with central banks to the extent that these deposits can be withdrawn in times of stress;
• Transferable assets that are of extremely high liquidity and credit quality;
• Transferable assets representing claims on or guaranteed by the central government of a Member State or a third country if the institution incurs a liquidity risk in that Member State or third country that it covers by holding those liquid assets;
• Transferable assets that are of high liquidity and credit quality.

The criteria upon which the EBA is to base its decision, listed in Article 481, are:

• minimum trade volume of the assets
• minimum outstanding volume of the assets
• transparent pricing and post-trade information
• credit quality steps referred to in Sub-section 2 of Annex VI
• proven record of price stability
• average volume traded and average trade size
• maximum bid/ask spread
• remaining time to maturity
• minimum turnover ratio

Until the EBA gives its verdict on which assets can be classified as being of high or extremely high liquidity and credit quality, “competent authorities” are to provide guidance based on these criteria.

The relevant documents can be found here:

http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm