EC launches covered consult, ‘voluntary’ EBA convergence an option

The European Commission is open to allowing voluntary convergence of covered bond frameworks around EBA best practices, alongside a possible tightening of CRR eligibility, as an alternative to legislating moves towards harmonisation in a consultation paper released on Wednesday.

The paper comes as part of the Commission’s Capital Markets Union (CMU) project and was released in parallel with a broader package of measures. The covered bond consultation was flagged in February alongside a CMU green paper that suggested that a “more integrated European covered bond market” would serve as an effective instrument to facilitate “cost-effective funding of banks and provide investors with a wider range of investment opportunities”.

The Commission said in this week’s documents that it is seeking to “promote a more integrated EU framework for covered bonds based on high quality standards and best market practices”, stating that the disparity between national frameworks could have contributed to market fragmentation, “hindering efforts to promote market standardisation in underwriting and disclosure practices thus resulting in obstacles to market depth, liquidity and investor access (in particular on a cross-border basis)”.

The Commission presented two options in the consultation paper:

• Voluntary convergence of Member States’ covered bond laws in accordance with non-legislative coordination measures such as a Commission recommendation
• Direct EU product legislation on covered bonds, which could seek to harmonise existing national laws or provide an alternative framework

The first option could involve the Commission issuing a recommendation to Member States that they implement in their national legal frameworks best practices identified by the European Banking Authority in a July 2014 report.

“In this case, the Commission would have to give further thought to the recommendations from EBA in favour of strengthened eligibility criteria for the existing preferential treatment in the CRR,” it added. “Such strengthened eligibility criteria could provide an additional incentive for Member States to converge their legislative frameworks.”

The second, legislative option could involve a dedicated EU covered bond legislative framework, said the Commission, which would regulate covered bonds as a legal instrument rather than just their prudential treatment. This could involve provisions on high level elements such as: a definition of covered bonds and protection of the term; issuers and the way in which they are supervised; the dual recourse principal and insolvency/resolution regimes; cover pools; and transparency requirements.

“A dedicated EU covered bond legislative framework could be achieved through various degrees of harmonisation of the above elements in national covered bond laws in accordance with a directive,” said the Commission. “This could provide a flexible approach by combining detailed requirements in some areas and high level principles in others, and offering a choice between minimum and maximum harmonisation as appropriate.

“A directly applicable regulation that would replace at least partly covered bond laws of Member States would be another option, but it would appear more challenging at this stage given that covered bond laws are well developed and deeply-rooted in the legal tradition of many Member States.”

The alternative legislative option outlined by the Commission is a so-called 29th Regime, whereby a comprehensive EU law framework would be an alternative to national laws.

The consultation paper includes a section dedicated to discussing potential elements in any potential regulation or legislative framework.

Market participants expressed relief that the Commission is envisaging a “harmonisation-lite” approach in the consultation.

“Bottom line, I would say for now that the EC is realistic that the way forward is via increased minimum standards in the areas that EBA already highlighted in their best practice guidelines (transparency, OC, liquidity risk mitigation techniques as well as supervision) and not via a brutal European system that replaces and overrules existing structures,” said Florian Eichert, head of covered bond and SSA research at Crédit Agricole CIB.

The Commission also noted that the drive for reform has initially been led by market participants, citing the Covered Bond Label initiative of the European Covered Bond Council (ECBC) as an example, although it said that there are limits to what market-led initiatives can achieve.

“The ECBC is glad to see the Commission confirm the intention of having a principles-based approach to harmonisation in the covered bond space,” said Luca Bertalot, secretary general of the EMF-ECBC. “This should not be seen as the skeleton of a directive. The new Commission has no intention to introduce unintended costs and is very keen to keep the covered bond as a strategically important instrument for Europe.

“It is important to note that there is recognition of the Label initiative and the role that it can play in transparency,” he added.

Bertalot said that the industry body will convene its supervisory taskforce including national representatives to work on its response, which it will deliver after meeting with the Commission in mid-November.

The consultation runs until 6 January.