Financial Industry Alert
On 20 December 2016, the European Banking Authority (the "EBA") published the final version of a report entitled "EBA Report on Covered Bonds - Recommendations on Harmonisation of Covered Bond Frameworks in the EU" (the "Report"). The Report builds on previous work and provides additional recommendations on how to further harmonise the national legislative frameworks on the covered bond instrument.
In response to Recommendations of the European Systemic Risk Board (ESRB) and following the publication by the EBA of their Report on EU Covered Bond Framework and Capital Treatment*, the EBA began an extensive analysis of the regulatory and legal framework for covered bonds in individual Member States, with a specific focus on alignment with the EBA's best practices.
More recently, in March 2017 the European Covered Bond Council (ECBC) announced that it supported the Report's recommendations and offered its collaboration to implement the harmonisation of covered bonds across the EU in the most effective way.
The aim of the Report was to:
The Recommendations issued by the EBA are as follows:
Recommendation n. 1 – Three-step approach to the harmonisation of the European regulatory framework for covered bonds.
Recommendation n. 2 – Development of a covered bonds directive (the "CB Directive").
Recommendation n. 3 – Amendment of EU Regulation 575/2013 (the "CRR").
Recommendation n. 4 – Voluntary convergence of national rules governing covered bonds.
The Report suggests implementation of the above four Recommendations in three key steps which are summarised below.
The proposed three-step approach builds on the strengths of the existing national frameworks, but allows better regulation of covered bonds in order to achieve a broad harmonisation throughout the EU. The adopted model provides for the development and implementation of framework legislation ensuring more a consistent approach, particularly as regards prudential standards, generally applicable in all Member States, and which replaces the discipline currently contained in Article 52, paragraph 4, of Directive 2009/65/EU (Undertakings for Collective Investment in Transferable Securities – UCITS) (the "UCITS Directive"))** .
In particular, European legislation should define structural requirements for covered bonds with specific reference to:
The CB Directive would become the new European regulatory framework, ensuring a uniform development of the same legislation in all Member States, granting each Member State sufficient flexibility to safeguard its specific needs.
The second step of the process provides for amendments to the sections of the CCR dealing with covered bonds. Currently, the CRR deals with the regulation of covered bonds with reference to the following three main aspects:
With reference to the risk weight treatment of covered bonds, the EBA recommends that the CRR is amended to be aligned with the provisions of the newly introduced CB Directive. In particular, with reference to Art. 129 of the CRR:
The third and final phase seems to be less binding than the others; in any case, it will depend on the actions taken by individual Member States. In this respect, the EBA recommends and encourages voluntary convergence between national frameworks also for other aspects (i.e. portfolios of assets constituted by underlying homogeneous activities or debtors located in jurisdictions not belonging to the European Economic Area).
Taking a long-term view, the EBA believes that such spontaneous and non-binding approach to legislative reform could lead to extended homogeneity across the Member States.
The table below provides a summary of main principles of the harmonisation programme recommended by the EBA described above.
Development of a covered bond framework (directive
Amendments to the CRR (related to preferential risk weight treatment)
Establishment of the base-line definition of the covered bond for EU financial regulation
Replacement of the covered bond-related provisions in UCITS Directive
Focus on structural features
Point of reference for prudential regulatory purposes (e.g. BRRD, LCR)
Applicable across sectors
Requirements in Step I obligatory for all covered bonds seeking regulatory recognition
Enhanced conditions for preferential risk weight treatment
Focus on credit risk related features
Requirements in Step I as well as Step II obligatory for all covered bonds seeking preferential risk weight treatment
Voluntary convergence of national frameworks through non-binding instruments
Specific areas with less material impact on the overall robustness of the covered bond frameworks
1. Dual recourse, segregation of cover assets and bankruptcy remoteness of the covered bonds
2. Requirements for coverage, liquidity risk mitigation and cover pool derivatives
3. Requirements for the system of special public supervision and administration:
(i) Cover pool monitor
(ii) Supervision of covered bond issuer
(iii) Supervision in the event of issuer’s insolvency/resolution
(iv) Administration post issuer’s insolvency/resolution
4. Transparency requirements
5. Conditions for soft bullet and CPT covered bond structures
All requirements in STEP 1
1. Requirement for eligible cover assets
2. Limits on substitution assets
3. LTV limits for mortgage cover assets
4. Minimum overcollateralisation
1. Composition of the cover pools
2. Cover pools with underlying assets/obligors located in jurisdictions outside the EEA
3. LTV measurement and frequency of revaluation
4. Stress testing by the covered bond issuer
* This consultation also dealt with the issue related to the development of a harmonised European framework for covered bonds, admitting that legislative divergences between countries may pose a major obstacle in terms of liquidity and investment opportunities and highlighting the importance of several recommendations on best practices suggested by the EBA.
** In accordance with paragraph 1, first subparagraph. Member States may raise the limit of 5% up to a maximum of 25% if the obligations are issued by credit institutions having their registered office in a Member State and subject to a special public supervision for protection of bonds' holders. In particular, sums deriving from issue of such bonds are invested, conforming to the law, in assets able to cover receivables linked to the bonds for the entire duration and that, in case of insolvency of the issuer, would be used on a priority basis for both repayment of capital and payment of accrued interest. Where a UCITS invests more than 5% of its assets in bonds referred to in the first paragraph, issued by a single issuer, the value of such investments will not exceed 80% of the value of UCITS' assets. Member States shall communicate to the Commission the list of bonds categories referred to in the first subparagraph, as well as the categories of issuers authorised under the law and supervisory arrangements to issue obligations complying with criteria set out in the Report. These lists shall be accompanied by a description of the offered guarantees. The Commission shall immediately submit this information to the other Member States, along with appropriate comments, and make it accessible to the public. Such information may be exchanged with the European Securities Committee referred to in Article 112 (1).