EBA recommends against Level 1 for covered

The European Banking Authority (EBA) has excluded covered bonds from assets it has recommended should be eligible as extremely high quality liquid assets for Liquidity Coverage Ratio (LCR) purposes in a report to the European Commission.

In a statement on 20 December the EBA recommended only bonds issued or guaranteed by EEA sovereigns, EEA central banks and supranational institutions qualify as extremely HQLA, equivalent to Level 1 in the Basel III framework, citing the results of its analyses as well as the “great importance” of alignment with the Basel Committee on Banking Supervision rules. Covered bonds are included in a second tier of high quality liquid assets, equivalent to Level 2 under Basel III.

The recommendation confirmed fears that were raised in November when it emerged that the EBA’s Board of Supervisors was likely to reject calls for covered bonds to be given Level 1 status, despite an EBA analysis published in October showing the asset class as having similar liquidity to government bonds.

The EBA in its December report cited a lack of data on covered bond performance during real estate crises as a reason for covered bonds’ exclusion.

“Despite the excellent liquidity features showed by some covered bonds, doubts remain as to whether these findings are sufficient to justify a deviation from the international standards and their inclusion in the category of extremely high quality liquid assets,” it said, “in fact two-thirds of the observations come from markets that did not experience a real estate crisis.”

A covered bond analyst treated this justification with scepticism.

“They state that the data doesn’t cover periods where real estate markets were in deep stress and hence that the data that they have is not representative enough for them to use it,” he said. “To me they had enough data, came up with good results, and are now looking for an excuse to ignore it to get to more global harmonisation.”

The EBA’s report left market participants disappointed, although after news of its likely position emerged in November it did not come as a surprise.

The final decision, due in June, will be taken by the European Commission, a point highlighted by Luca Bertalot, head of the European Covered Bond Council.

“It is important to stress that EBA merely makes proposals to the Commission,” he told The Covered Bond Report.

“The Commission is, however, the one to make the final decision before the end of June 2014 and that decision can still look different to EBA’s proposals.”

Read an analysis by Florian Eichert, senior covered bond analyst at Crédit Agricole, on the implications for the euro market here.